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If you are thinking about taking a job teaching English in China, my strong advice to you is DON’T DO IT. Just don’t. Look for such a job in Vietnam or Thailand or Japan or Spain or the Chezk Republic or really just about anywhere else in the world. I say this becasue teaching English in China has become that corrupt, that horrible, that exploitive, and that risky.

Let me explain….

Our international lawyers have always gotten a steady stream of emails from English teachers in foreign countries who are in trouble or not getting paid. Though these matters are invariably too small for us (or just not the sort of work we handle), we do want to help to the extent we can. That “help” usually consists of an email providing “fly-by” legal or career help or even emotional support. We view helping these teachers as a bit of a public service.

In International Education: The Emails We Get, we explained how our international lawyers have inadvertently found themselves on the front lines with this, even though we have never made a single cent from representing an English teacher anywhere in the world.

A couple years ago we wrote a four part series on establishing an international school in China. In part 1, Establishing International Schools in China: The Basics, we discussed the complications foreign parties typically see when trying to start a school in China. In part 2, Establishing International Schools in China: A Deeper Dive, we focused on what it takes to start a School for the Children of Foreign Workers. In part 3, Establishing International Schools in China: A Deeper Dive (Continued), we discussed Sino-Foreign Cooperative Schools and Chinese Private Schools. In this, my last post in this series, I look at future trends for international schools in China. In Part 4, Establishing International Schools in China – Future Trends, we wrote about some of the distinctive issues foreign schools face in China. We also sometimes write about the legal issues stemming from teaching overseas. See e.g., Teaching English In China: Be Careful.

Many of our lawyers and staff attended international schools or are sons or daughters of teachers or professors. I spent my junior year of high school at Robert College in Istanbul, a year studying Spanish at LAE Madrid, and 8 months studying French at the Institut de Touraine. All three are amazing schools and these were some of the best years of my life. My father taught English Literature at a liberal arts college for 36 years. Our law firm has a long history of representing universities and international schools on their international legal work, ranging from helping them set up in foreign countries to licensing technology they’ve developed to foreign companies.

Our writings and our legal work and our various international school connections mean we get 10-20 emails every month from people teaching around the world, roughly be divided into the following four categories:

  1. Visa issues.
  2. Employment contract issues.
  3. Medical and landlord issues.
  4. Starting a school issues.

We went on to talk about how our international lawyers try to do their best to give responses that contain actionable advice, based on the limited time and information we have and the below reflects how we typically handle the four most common categories of foreign teacher emails.

1. Visa Issues. We almost always have to punt on visa issues because our immigration law expertise is mostly limited to business immigration to the United States, with a smattering of additional knowledge gleaned from the transactional work we do in Asia and in Europe. Since none of us have deep immigration law knowledge relevant for foreign teachers our response is usually to urge them to seek out a local immigration lawyer for assistance. I know from my own experience in other countries that there is a veritable ton of bad and outdated immigration law information on the internet and an hour or two with a lawyer who actually knows this area of law can be invaluable. This is pretty much true of all aspects of international law. See China Law Online: It’s All Wrong.

2. Employment contract issues . The typical email we get will say something like “I am a teacher in China and I have been fired for taking a day off because my sister came to visit. Can my school do this?” Our response to this sort of email will usually be something like the following — changed quite a bit for brevity and for emphasis:

I have no idea whether your school can or cannot and for us to know we would first need to make sure we do not represent the school at which you worked (because if we did, we could not represent you) and then we would need to read your contract and then compare that as against the local laws and the province’s laws and China’s laws and then maybe speak with the local employment authorities as well. If it does turn out that the school illegally terminated you we would then need to figure out exactly what we can do about that. Likely that would be registering a complaint with the appropriate Chinese governmental body and using that to try to pressure your employer to take you back, which is very unlikely to happen. When you are not taken back we would then need to look into suing the school. If we did sue the school and you won, we might get an order saying the school needs to take you back and we might get some really small amount in damages. Then again we might also lose. Your school may or may not abide by the order.

The problem with the above is that at some point your China visa may be revoked and you will need to leave China. And win or lose, you challenging this school may lead to you never getting a job in China again and going through the above will be time consuming and expensive.

3. Medical and landlord issues. These emails often come down to money. “The hospital wants $400” or my “landlord wants to raise rent by $100 a month.” As a father, my responses to these are usually nine parts paternalistic, one part legal.

4. Starting a school issues. The typical email will come from someone who has been teaching English in China or in Vietnam or in Poland or wherever and they now want to know what it will take “to open a school for foreign students in X city in Y country.” We then explain the basics of what setting up a school will require and the estimated costs.

Since relations between China and the West (especially the English speaking West) started going into straight line decline about a year ago, the number of these emails have increased exponetially and the problems have shifted. The problems we are seeing these days generaly fit into the following three categories:

1. English teacher in jail for a fight or for drug possession. Our advice is to have someone close to them reach out to their country’s embassy and work with the embassy in securing a good local criminal lawyer. We urge them to act quickly and, if at all possible, secure financial support from their parents. We urge them not to publicize their case unless and until their retained lawyer suggests that be done, which is rare.

3. Visa issues.  We usually suggest the teacher work with their school to try to solve these problems (if they trust/like their school) and/or get a good local immigration lawyer/visa specialist to assist. Occasionally we suggest the teacher leave the country.

4. Non-payment or underpayment. These usually involve the school perpetually underpaying, the school being late with payment, the school not paying promised bonuses, not paying for extra hours, not paying the final month’s paycheck under the contract or not reimbursing or paying for the flight home (as per the contract). Our advice is usually to let it go because finding and hiring and paying for a lawyer will likely be difficult and the teacher (just as with the work related problems mentioned above) may well be better off long-term by not making waves.

Pretty routine stuff right? Yes and no and it is the “no” part that is causing me to write this post. The no part is that in the last three months these issues have gone into warp speed. Speaking just for myself, the number of these emails has gone from one or two a month to four to five a day. I have seen at least a ten-fold increase in prison, visa and payment problems for teachers from China (and nowhere else in the world). It has gotten relentless to the point of being depressing. If the emails we are relentlessly receiving are any indication (and they have to be), the following is happening in China in what feels like every minute:

  1. Teachers are being drug tested using their hair samples. Many are testing for cannabis and being jailed for 30 days or more and then being deported. This is happening to newly arrived teachers who insist they did not consume any cannabis since arriving in China. Listen up everybody, cannabis can show up in hair testings up to (and even sometimes beyond) 90 days after you have consumed it. So if you are going to be teaching in China and you do not want to spend time in jail and get deported, please, please, please go at least four months without consuming ANY cannabis before you go there and please, please, please do not consume any cannabis while there. None. Zero. Zilch. 没有. Aucun. Keiner.  PLEASE. Invaribly, the schools use this as a reason not to pay the teacher whatever is owed.
  2. Teachers are being checked (or reported on) for having an improper visa for China. The teachers are then being tossed in jail and then deported or just deported straight away. Invariably, the schools use this as a reason not to pay the teacher whatever is owed. It appears to have become very common (as a cost cutting measure) for schools to have teachers come to China and start their teaching on tourist visas, all the while claiming this is perfectly legal — it isn’t. The teachers believe this until the day they are arrested. Near as I can tell, the schools rarely if ever get in any real trouble for this but the teachers sure do.
  3. Teachers are not getting paid. Just this morning I got an email from one teacher who say that she and another 75+ teachers in her city (from various different schools) have not gotten paid for months. And another email mentioning nine teachers in another city who also have not been paid.  Add to this the pretty much daily emails I get from teachers who do not get their last paycheck or the airfare reimbursements or the bonuses they were promised and it has become clear that it is open season right now against foreign teachers in China. The schools clearly believe they can blow off paying their teachers with impuntiy because they are right. When teachers ask me what they should do about getting paid my response is usually to say that they can retain and pay a local Chinese attorney to try to get paid, but the odds of a foreign teacher prevailing on such a claim are not good and pushing at all hard to get paid can have all sorts of negative ramifications. Schools will pull teacher’s work visas or refuse to assist in moving it to a new employer. They may also seek to have you deported so they can be sure to avoid having to pay wages owed and it is not uncommon for schools to make up claims about their teachers and to threaten to “make sure they will never work in China again.” You therefore need to think long and hard about getting bogged down in these sorts of disputes and even how they might harm your long term career prospects.

From beginning to end, the game is rigged against English teachers in China. The China employment relationship is complicated and if done wrong, employees can and do end up in jail. The only relevant portion of a China employment contract is the Chinese portion and so teachers who do not speak Chinese have no clue what their employment contracts say and no clue even whether the English language portion of that contract accurately translates the Chinese portion — I can tell you right now that the odds are about 100 to 1 that it does not. And even if you are able to read the Chinese portion, unless you have a comprehensive knowledge of China’s employment laws in the specific locale in which you are working. Our China employment lawyers consistently represent high-level China employees in their employment contract negotiations but English teachers simply cannot afford such assistance. This makes them incredibly vulnerable from day one and their employers know this and they don’t hesitate to take advantage of it.

I have reached the conclusion that the best thing an English teacher can to do protect themselves from the sorts of things mentioned above is not to take a teaching job in China in the first place. Go elsewhere. And if you are teaching in China now, leave now or just resign yourself to your fate. I wish I could give better advice than this but I cannot. Sorry.

So how is the above relevant for non-teachers. I’ll tell you. The truth is that many Chinese companies prefer to hire foreigners illegally to legally because doing so can save them a ton of money and is usually pretty low risk — at least for them. So what I describe above regarding teachers is not as uncommon as you would think in other industries. The Global Times article, The detention of two Irish women who were working side jobs at an unlicensed school in Beijing shines a spotlight on the illegal English education market in China is about  two teachers from Ireland who were detained in prison for more than a week for working illegally in China. Both these teachers had visas that allowed them to work full-time in China, but only with their one employer who secured these visas for them. These two teachers had taken lucrative part-time teaching jobs on the side and it was those jobs that got them arrested.

The Global Times article says the big takeaway from what happened to these two teachers is that “employers have no qualms about hiring foreigners illegally” and “when the illegality is discovered, it is the foreign worker who gets the blame.” It then discusses the following “experiment”:

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

And the getting fooled by the English portion of the employment contract happens in all industries too. We discussed this in Dual Language China Contracts: Don’t Get Fooled!

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

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

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

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

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

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

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

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

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

Living and working and doing business in China is way more legally complicated than ten years ago and tolerance of foreigners in China (particularly for Americans) is way down. This means that the likelihood of you going astray of Chinese law is considerably higher as well. When you..

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Way back in 2007, we did a post on attorney ethics in China, entitled, China Lawyer Ethics — Perils And Pitfalls For Foreign Companies. In that post, we discussed a blog post entitled, Time to Raise The Professional Ethics Bar for Lawyers in China?  In that post, American lawyer Brad Luo  noted that China’s ethical rules for lawyers have a “bright line” rule forbidding them from representing both sides in the same conflict, but they go little beyond that. Brad wrote how he was troubled by how China does not require lawyer loyalty to former clients and how this means lawyers can turn on their own clients without offending their duty of confidentiality to either of them.

In  a subsequent post, Time to Raise The Professional Ethics Bar for Lawyers in China? (II), Brad rightfully describes “confidentiality” as “the bedrock of an open and trusting relationship between a lawyers and clients” and notes that American lawyers must keep client confidences “strictly confidential and secret.” Chinese lawyers, on the other hand, are prohibited from divulging only “’national secrets, clients’ trade secrets, and privacy of parties’ learned by the lawyer during representation.” “Personal privacy is not defined and Brad sees it as being fairly limited and he concludes that the “duty of confidentiality as stated in [China’s] Current Lawyer’s Law and Ethics does not provide sufficient protection to clients.

Brad concludes this post by saying “if I were a client, I’d hesitate talking about certain things, not even with my Chinese lawyer.” Brad is dead on with this advice and foreign companies using Chinese lawyers must be cognizant of this and this is something our China lawyers constantly have to explain to our somewhat disbelieving American clients. The following are some concrete examples where companies have paid a stiff price by not accounting for how lawyer-client issues differ across borders.

Many years ago, a couple of our international lawyers were meeting with in-house legal counsel for a very large Korean company, or chaebol. We were  there representing the chaebol on a matter, but the in-house counsel wanted to use our meeting as an opportunity to “pick our brains” about another fairly small, but somewhat complicated, multi-party case on which he was working. The other case involved an alleged breach of contract and a number of American high tech companies. The case was pending in a Korean court and settlement talks had just begun. The in-house lawyer spent maybe ten minutes explaining the facts of the case and the various players to us and once we had reached a point where we felt we understood its overall outline, the in-house lawyer handed us a two page letter to review.

The letter was written by an American attorney, on behalf of his American client, to the Korean lawyer representing the American company in Korea. The letter talked about how the American company wanted to settle the case for a million dollars, but it would be willing to take $600,000. The letter then instructed the Korean attorney to start settlement negotiations at $1.4 million.

Seeing as how my client had a copy of this letter, I initially assumed the American company whose settlement strategy was revealed in the letter was on the same side in the Korean case as our Korean client, and we read the letter accordingly. We then read the letter again and then we read it a third time. We were really confused and we confessed as much to the Korean in-house lawyer. We told him we had thought the American company whose settlement strategies were being discussed was the American company suing the chaebol, but we obviously must have misunderstood the facts. The Korean in-house lawyer (who had an American legal degree) smiled and then explained.

The American company in the letter was on the opposite side of the chaebol in the case and the letter setting forth the innermost workings of the American company’s settlement strategy directly involved the American company’s efforts to settle with the chaebol. Our Korean client had been given this letter by the American company’s Korean attorney because this Korean lawyer had attended the same Korean law school as the in-house lawyer and had started law school a year or two later, making the in-house Korean lawyer his “big brother.” The opposing Korean lawyer would golf once or twice a year with the in-house Korean lawyer and had been trying to secure legal work from this chaebol for some time.

We have since then learned of multiple instances where Western companies (it is always Western companies and Northern European and Australian companies seem particularly susceptible to this) have overpaid or been cheated from having their own lawyers reveal confidences to the other side. We have seen/heard of this happening in all sorts of deals, but most commonly in joint venture deals and in large procurement deals. In the end, this form of cheating is essentially the same as your standard run of the mill kickback deal, but involving your own lawyer.

The attorney-client privilege is a long-established principle in the United States (and generally in all of the Western world as well), recognized under English common law since at least 1576 (Berd v. Lovelace). The privilege fundamentally informs American company expectations of the legal profession, to a degree that creates dangerous assumptions when dealing with lawyers in jurisdictions outside the common-law tradition, where the privilege might not be as extensive—or may not exist at all.

By way of example, under Washington State law, “An attorney or counselor shall not, without the consent of his or her client, be examined as to any communication made by the client to him or her…” (RCW 5.60.060(2)(a)), while the bar rules hold that “A lawyer shall not reveal information relating to the representation of a client unless the client gives informed consent…” (RPC 1.6). According to the U.S. Supreme Court’s decision in Hunt v. Blackburn (1888), the privilege “is founded upon the necessity, in the interest and administration of justice, of the aid of persons having knowledge of the law and skilled in its practice, which assistance can only be safely and readily availed of when free from the consequences or the apprehension of disclosure”

The Supreme Court’s reasoning seems compelling, but clearly its views are not universal. In China, for example, lawyers have a general duty of confidentiality (Art. 83, Law on Lawyers), but there is nothing to stop them from bearing witness against their clients in civil cases. And though Chinese criminal defense attorneys can choose to maintain confidentiality (Art. 46, Crim. P. Law) regarding their cases, the same discretion does not legally extend to other lawyers. Under this legal framework, an attorney defending someone accused of tax evasion could choose not to testify against their client, but the defendant’s tax attorneys would not be similarly protected.

In addition to these legal considerations, there are also practical ones. American lawyers are rightfully terrified of disciplinary action. Bar associations take complaints seriously and, for the majority of lawyers, disbarment would be a critical blow, both financially and reputationally. This is not to say that lawyers in China are not subject to disciplinary oversight from the government and bar authorities: they are. However, a study of disciplinary cases in Zhejiang found that only 11 out of 122 cases reviewed involved “some aspect of client protection”. Political concerns and the protection of law firms’ interests were usually the driving force.

It is hard to see how the average Chinese lawyer would be fearful of the consequences of revealing confidential information, especially if the affected client is a foreigner, even more so these days if it is an American company This means you are in a vulnerable situation if your Chinese lawyer stands to benefit by revealing information you provide. Perhaps your lawyer has another client who would just love to take a look at that new patent application of yours. Perhaps your law firm stands to benefit by tipping off your competitor before it files your trademark application. Or maybe it will be as simple as revealing that you told them that you would have paid $10 per widget, not just the $8 written in your contract. Worse yet, what if your lawyer is in hot water with governmental authorities and reporting the missteps of a foreign company will help them curry favor? Trust us when we say that all of these nightmare scenarios are real life possibilities.

Mindful of all this, savvy clients often take their China work to lawyers bound by the strict confidentiality rules of foreign countries. Of course, on occasion some information may need to be revealed to Chinese co-counsel, but it will be done in a careful, need-to-know basis. And of course there will also be times where using a Chinese lawyer is imperative.

Even in countries that do recognize some form of privilege, issues can still arise. For instance, in-house counsel cannot invoke attorney-client privilege in some jurisdictions. This is the case in France and Italy, where in-house lawyers are not considered members of the bar and are therefore not subject to rules of professional responsibility. Your CEO client needs to understand that conversations with the avocat d’entreprise at the company’s French subsidiary are not protected in the same way as chats with the general counsel back home. Sometimes, outside counsel will be brought in to participate in meetings to make the discussions confidential.

Needless to say, you do not want to find out that your communication is not privileged after you have disclosed confidential information. The best course of action will usually be to talk to your international lawyers in the United States and design appropriate strategies before engaging with lawyers abroad. These lawyer trust issues have been out there for a long time, but with the increasing tensions between China and the United States, they are and will continue coming to the fore and this has spurred us to write about this again.

Be careful out there. Like really careful. ​

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Our lead China entertainment attorney, Mathew Alderson (who Variety Magazine named as one of the 50 most influential entertainment lawyers) will be speaking on a panel at the Westin St. Francis, San Francisco, on June 28. The panel is entitled “The Impact of Regulatory Changes on China’s Entertainment Sector: Trends and Challenges.” Mathew’s panel will be part of the 2019 Summit on Commercial Dispute Resolution in China, presented by The Beijing Arbitration Commission in association with JAMS.

The panel will focus on how recent regulatory changes in China are affecting Hollywood and the media and entertainment sectors in China. The event will be moderated by JAMS mediator and arbitrator, Jeffrey G.Benz. The other panelists will be Allbright Beijing’s James Tian and JAMS mediator and arbitrator Barbara Reeves.

China’s media and entertainment industry is, in many ways, on the front lines of the recent US-China trade war and it has already been greatly impacted by it. In Chinese cinema eclipses US box office as Hollywood films suffer during trade war, the Telegraph newspaper nicely sums up much of what is happening to Hollywood entertainment in China these days:

China is targeting Hollywood in a new escalation of its trade war with the United States, refusing to show Western films in cinemas and on television, and sacking American actors.

The move is intended to damage an iconic US industry as tensions between the world’s two largest economies remain high.

It also comes as China is set to overtake the US as the country with the biggest box office takings in the world next year.

Foreign movies and entertainment are getting hit by a double whammy as China seeks both to retaliate against U.S. tariffs and crack down on foreign influences. And as is true of so much of what China does with foreign companies, this crackdown against foreign entertainment is being done “unofficially””

It’s Hollywood, it’s a strong industry for America and it’s symbolic” Dan Harris an international lawyer advising clients doing business in China, told The Telegraph. “With the film industry there are levers China can pull and push as much as they want. That’s what we’re hearing they’re now doing. It’s a matter of degree, but it’s being ramped up and and it will continue to escalate. All of a sudden you realise there are no Western movies.”

There has been no official directive from the Chinese government but industry figures indicate not-so-subtle pressure has been brought to bear and a “de facto” policy is in place.

*    *    *    *

The Los Angeles-based Independent Film and Television Alliance, which represents independent film companies in the US, said the developments were an “extreme setback”.  One industry insider said: “We just don’t know if it’s going to be possible to get release dates for American movies.”

A clear signal of China’s intent to target US-produced entertainment came two weeks ago when Tencent, the Chinese internet giant, cancelled streaming of the final episode of Game of Thrones. The series is highly popular in China. Over the Sea I Come to You, a Chinese TV series filmed  in the US with American actors, was also cancelled.

One, who asked not to be named, told Variety: “Essentially overnight many Americans have been left with no on-screen prospects. Some were fired, some had auditions cancelled, and essentially all our phones have stopped ringing.”

If you are interested in the issues confronting Hollywood in China you should go. The conference runs from 9 a.m. until 6 p.m., with the post-event reception scheduled to last until 7:30 p.m. Go to this link to register. Mathew’s session starts at 2:15.

We hope to see you there.

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As we have discussed in our recent posts, the U.S. and China are now engaged in a process of economic restructuring. See The US-China Trade War: Winter is Coming (published one day before President Trump tweeted out the newest tariffs) The US-China Cold War Starts Now: What You Must do to Prepare (published three days after the tweeted tariffs). The Section 301 tariff dispute is only one aspect of a much larger process  we have been calling the New Normal. See China, the United States and the New Normal (from October 6, 2018) The New Normal has already and will continue too impact many areas of U.S./China financial cooperation. One important area it will greatly impact is the access of Chinese companies to U.S stock markets.

It is estimated that more than 200 Chinese companies have listed in various ways on U.S. stock exchanges with an estimated total market value exceeding 1.8 trillion U.S. dollars. Even at the height of the trade war, NASDAQ continues to announce that Chinese companies will do IPOs on the NASDAQ exchange. These IPOs are economically important to  NASDAQ and NASDAQ officials have stated that they welcome the new listings and are hoping for more in the future. See Nasdaq executive dismisses ‘discredited’ Steve Bannon’s call to bar Chinese companies from US capital markets.

But there is a fundamental problem with Chinese listings. The central core of the U.S. stock markets is that publicly listed companies are subject to financial oversight. First, they are audited by accredited U.S. auditing firms. Second, these audits are further monitored by the Public Company Oversight Board (PCOB). These regulations are applied with rigor against U.S. and European companies that list in the U.S., but Chinese companies are entirely exempted from such oversight.

This exemption from oversight is a product of Chinese government regulation. The Chinese government takes the position that allowing a foreign agency like the U.S. Securities and Exchange Commission (SEC) or the PBOC to audit Chinese companies on Chinese soil is an offense against Chinese government sovereignty. The initial response to this position was for the SEC/PBOC to say: fine, then just send the audit reports to us in the U.S. and we will audit over here. The Chinese then shut that option down by taking the position that the audit reports of Chinese companies constitute a Chinese government state secret. As a state secret, the audit reports cannot be allowed to leave China. According to a joint statement by the SEC and PCAOB from December 2018:

The business books and records related to transactions and events occurring within China are required by Chinese law to be kept and maintained there. China also restricts the auditor’s documentation of work performed in the country from being transferred out of China. . . . China’s state security laws are invoked at times to limit U.S. regulators’ ability to oversee the financial reporting of U.S.-listed, China-based companies. In particular, Chinese laws governing the protection of state secrets and national security have been invoked to limit foreign access to China-based business books and records and audit work papers.

Stated more directly, unlike companies from the U.S. and Europe and everywhere else in the world, Chinese companies that list on the U.S. stock exchanges are exempt from meaningful financial oversight. This is a longstanding scandal that is finally coming to a head. On June 5, U.S. Senators Marco Rubio (R-FL), Bob Menendez (D-NJ), Tom Cotton (R-AR) and Kirsten Gillibrand (D-NY) introduced the Ensuring Quality Information and Transparency for Abroad-Based Listings on our Exchanges (EQUITABLE) Act. U.S. Representatives Mike Conaway (R-TX), Tim Ryan (D-OH), and Mike Gallagher (R-WI) introduced companion legislation in the House. See Disclose or leave: US bill vows to delist even biggest Chinese players As explained by Senator Rubio, this Act is intended to achieve the following three goals:

  1. Force the PRC government to allow full access for audit of Chinese companies listed on U.S. exchanges.
  2. Where such access is denied, compel those companies to delist. Under the current plan, the companies will be given three years to delist. The current view is that these companies will move to the Hong Kong exchange.
  3. For the future, Chinese companies that fail to comply with the audit requirement will not be permitted to list.

The likelihood that the Chinese government will comply with this demand is at most two percent. This then means that if this legislation is passed (which is looking likely), all Chinese companies currently listed on the U.S. markets will be delisted and no future listings from Chinese companies will be permitted on the U.S. markets.

The operators of NASDQ have openly expressed opposition to this legislation. In a NASDAQ report, the author stated: “But torching shares valued at around $1.8 trillion is a harsh price to pay for transparency.” See China audit crackdown is a Wall Street nightmare. This is the same argument the SEC has been using for years to justify its refusal to take action on this issue. The argument is essentially that the damage has been done and now requiring the delisting of these unregulated Chinese companies would cause more harm than good. This was always a weak argument. However, the ultimate failure of the argument is that Chinese companies continue to list. They continue to be unregulated. So the damage increases as the SEC looks the other way. For a short history of Chinese company stock fraud on US stock exchanges, check out The Dirty $50 Billion Scam Wall Street Is Getting Away With.

The argument of the SEC and NASDAQ is nonsense. “Transparency” is at the core of the U.S. public market system. Torching shares at ANY valuation is a required price to pay to maintain transparency. It makes no business sense to allow the PRC government to harm the integrity of the U.S. public markets merely to allow the listing of shaky IPOs. Members of Congress see this and so they are taking direct action to remove authority from an unresponsive SEC.

It is not clear whether this legislation will be adopted. Wall Street opposes it and you  do not need me to tell you that Wall Street is very powerful. Moreover, the SEC has allowed this scandal to continue for decades and unwinding it now will be a Wall Street nightmare, as commentators have quite accurately pointed out. Moreover, the net effect will be to push this business to Hong Kong, to the ultimate detriment of the U.S. markets. So the stakes are high and the arguments will be intense.

Readers should note that the argument of Wall Street and the SEC has been: the damage has been done and we just have to live with it. This is similar to the response of many U.S. retailers on the tariff issue. A large group of retailers just sent the Trump administration a letter requesting it back off on tariffs against China, using a similar argument: the damage has already been done. The China price is already built into the structure of American business and it is too damaging to fix the situation now. So the U.S. should just back off and go back to the Old Normal. See Over 600 U.S. companies urge Trump to resolve trade dispute with China: letter.

Though this argument at first sounds ridiculous, it is in fact a very powerful, made even more powerful by its being made by some exceedingly powerful constituencies. The U.S. has allowed the situation with China to progress to this point at least since the Clinton administration. The current U.S. economy has been built on a foundation provided by China as manufacturer for the world, creator of the China price, and investor in U.S. stock markets.

Is the U.S. now willing to endure the pain of dealing with the issues? Will the United States  continue to allow unregulated Chinese companies to list on the U.S. public markets? Will it continue to chase the China price by allowing China to export its government created surpluses into the U.S.? The answers to these questions are not clear. But at least the issues are clear.

Right now, the prevailing view is that no matter who wins the U.S. presidency in 2018 that person will be at least as “anti-China” as Trump. Way back in August, only 38 percent of Americans saw China favorably and I presume that number has dropped considerably since then. Even if the next President is pro-China, she or he will likely be too late to change much.

Chinese investment in the U.S. is down “by nearly 90 per cent since its peak in 2016, including a sharp drop in 2018 and early 2019.” All sorts of companies have moved their manufacturing from China or are scrambling to do so. See Google is moving US-bound Nest production out of China (“Google’s production shift is part of an increasing trend. GoPro is moving its US-bound production to Mexico. Yesterday, Foxconn said it was prepared to move the production of US-bound iPhones outside of China before new tariffs as high as 25 percent kick in at the end of the month.”). The international lawyers at my firm are all working overtime helping our clients move from China to countries like Thailand, Vietnam, Malaysia, Taiwan, Mexico, etc.

No matter what happens with the tariffs, we are going to keep seeing large numbers of anti-dumping and countervailing duty cases being brought against goods coming into China and the duties that stem from those cases are going to lead to an effective ban on huge numbers of products from China. Or as one of my firm’s international trade lawyers puts it:

Truth is that with all the trade issues involving China and bipartisan anti-China sentiment prevalent in the United States, now is a great time to bring such actions. The international trade lawyers at my firm mostly defend against antidumping and countervailing duty claims instead of bringing them — we represent mostly the overseas producers and exporters and the US-based importers — so I say all this not to encourage more such actions, but as a simple statement of fact. If you are importing products from China, you need to assess and know the trade risks of your imports and to think about alternative sourcing.

Based what I keep hearing from my own firm’s China lawyers and international manufacturing lawyers, many American and European companies are seeking to diversify their product manufacturing away from China. See China-US Decoupling Continues and Will Continue, but Must be Done Right and China Manufacturing: Is the Bloom now Off That Rose? and The China-US Trade War and the Winner is….MEXICO. It appears US foreign policy is to drive business from China to countries like Mexico (note how quickly President Trump’s mini-tariff war with Mexico was resolved), the Ukraine, Vietnam, Thailand, the Philippines, and Indonesia, among others. What this means big picture is that the price of products coming from China to the United States will continue rising and, as one of our China lawyers so often tells our clients: “you need to act accordingly.”

Earlier this week, Bloomberg Businessweek did a big story on how the FBI and the National Institute of Health (NIH) are investigating and  “purging Chinese cancer researchers from top institutions.

With so much US-China decoupling already having happened and so much more already in place to happen — pretty much no matter what — I have to wonder how many legitimate Chinese companies are still looking to list in the United States in any event. Even if this ban on Chinese stocks is not passed, will the Chinese government allow its companies to list in the United States? Who does not believe the Chinese government is not already pressuring Chinese companies already on American exchanges to leave them? See China opens Nasdaq-style board to lure tech firms back home. I realize there are a large number of Chinese companies set to IPO in the United States in the next year, but with China’s new board taking only “profitable companies,” and the incredibly poor performance history of so many Chinese companies that have done U.S. IPOs, I cannot help but wonder whether even a majority of these planned IPOs will happen even if the ban does not go through. In other words, is the economic damage NASDAQ and the SEC are touting even close to reality?

In It’s time to end the ‘China hustle’ on U.S. stock exchanges, Paul Gillis, one of the leading experts on Chinese public company accounting practices calls for the United States to crack down on Chinese companies listing on US stock exchanges:

“We’re bending our laws again for the Chinese for the sake of making money,” said Paul Gillis, professor at Peking University’s Guanghua School of Management. “Ordinary Americans are not aware they have a rising exposure to firms that are not adhering to U.S. laws.”

What are your thoughts?

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This is part 5 of our series on eight+ things to read about China and a lot more. We constantly get emails from readers asking what to read on China and all sorts of things related and even barely related to China and this series is intended to constantly and consistently answer these questions.

As I said in our initial post on this, our plan is to list out eight (or so) articles we benefitted from reading and think you our readers would also benefit from reading, along with a very brief explanation why the particular article was included. More specifically:

The articles will likely include many on China and on Asia and a few on international trade, international politics, Spain and Latin America, economics and really just anything else we believe might benefit our readers or even that we just want people to read. We do not plan to choose articles that push our or any other political agenda or any other agenda for that matter, but having said that, we are not objective and our views may creep through. Our goal though is to focus on articles that are important or helpful or — most importantly — that make you think. Our posting of an article will NOT mean we agree with all of it or even any of it. Most of the articles will be from the week preceding the post but we will also sometimes throw in older articles (classics if you will) as well.

Please do not hesitate to comment at the end of this or any other post. We cannot tell you how much we appreciate your comments, good, bad and indifferent.

Here we go, in absolutely no particular order.

1.  Hong Kong Is on the Frontlines of a Global Battle For Freedom. Time Magazine. Because it is and because the war between freedom and authoritarianism is a never-ending one and because this article fairly and accurately summarizes the issues. Because the world needs to know what is happening in the Sudan and the U.S. media has utterly failed to cover this story. Because China and Russia are helping to prop up the dictatorial regime there. See also Ivan Golunov’s Russian release: Why this case matters if you want further proof that even authoritarian regimes

2. China Is Bluffing in the Trade War: Chinese leaders say they can effectively retaliate against Trump’s tariffs. They’re wrong. Foreign Policy.  Because “the simple fact is that China needs the United States more than the United States needs China. In itself, that’s no reason to start a trade war. But if the trade war really does heat up, there’s little doubt who will win.” See also The price of apples is soaring in China, and Beijing is showing concern.

3.   Saudi Teen Faces Death Sentence for Acts When He Was Ten. New York Times.  What kind of country would execute a teenager for having attended a political rally at the age of ten?

4. Kalamazoo Central high school performs “My Shot” from “Hamilton” at graduation. 105.3fm. Because this is my high school and because the video has gone viral (well over 100,000 views so far) and because it is an urban high school that has a long history of struggles but also a long history of successes. See Obama at Kalamazoo Central High School: How did it win the honor? Because it is, in many ways, a microcosm of race in America. See A Flashback to Kalamazoo, Summer of 1967.

5. If Trump Wants to Take On China, He Needs Allies. And He Should Start with Europe. New York Times. Because we may be heading towards a bi-polar world divided between the United States and China and Europe likely will side with the United States. Because I like having allies and I see big differences between countries like Spain, France, Germany, Poland, Japan, Vietnam, Thailand, Mexico, Canada, Chile, Colombia, Kenya, Ghana, Nigeria, South Africa, Israel, New Zealand, Denmark, Morocco, Rwanda, and Australia on the one hand and countries like Russia, North Korea, Iran and China on the other hand and it is not clear to me that President Trump sees such distinctions. 

6. A $100M Bet That Online Coaching Can Make a Better Manager. Wired Magazine. See also Delta saves 41 stranded students with a private flight after American Airlines cancels trip. Fox. Because as my law firm continues to grow (we’ve doubled in size in the last two years) I’m becoming ever more convinced that employee happiness correlates with client satisfaction. Because Jeff Bezos always says that “the number one thing is to be customer obsessed; figure out how to delight them” and in the law business, a delighted (not just satisfied) client is a lifetime referral source. Yet law firms are notoriously bad (compared to other industries) at customer satisfaction.

7. Rage Rooms are all the rage. NBC. Because they are. Because after walking past an axe-throwing establishment in my eldest daughter’s neighborhood I realized the apocalypse is upon us and when my daughter then told me about rage rooms, I became even more certain that the world as we know it will soon be no more.

9. Russian Doll: How Female Mentors Helped Natasha Lyonne Tell Her Story. Vanity Fair. Because Russian Doll is unique and very good and because Natasha Lyonne is uber-talented.

10. The official candy bar power rankings. LA Times. Because it matters. Because one of the ways we would divide teams for pick-up basketball games while I was in high school was between those who liked Heath bars and those who didn’t — I’m not kidding on this. Because I still think of one of my best friends from my hometown (see above) every time I see a . Reese’s Peanut Butter Cup because that was all he would buy.

11. The Secrets of Food Marketing. YouTube. This video has nearly 10 million views and there is a reason for that; the power of willful ignorance can never be underestimated. It really is quite fascinating. See also Cocoa’s child laborers.

Your thoughts?

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                                                                                                                                       NNN v. NDA

American and European companies are always asking us to revise their template NDA “to make it work” for China. Our response is always to say that it will be much faster, cheaper, easier and better for us to just start all over with a China-specific NNN. I then tell them that NDAs do not work for China and that the way to protect their IP is with an NNN Agreement. Fairly often they then reveal that they have already done “some things” in China using an NDA” and then they almost invariably say something like, “at least better that is better than nothing. I usually respond with something positive (but ultimately noncommittal) like, “well, fortunately, we can now start taking substantive action to protect your IP from China.”

But the problem is that virtually all NDAs are in fact worse than nothing and here are just some of the reasons why.

  1. Your China counterpart knows the NDA it signed is worthless and your having given them that NDA to sign tells them that neither you nor those working for you (within or outside your company) know what it takes to protect IP in China. In other words, you have just told them that stealing your IP will be relatively easy.
  2. Your NDA probably says all disputes will be resolved in an American court under United States law. What this means is that if your China counter-party does steal your IP, you must sue them in the United States, which is exactly where you do not want to sue them. The reason for this is because China does not enforce United States judgments and so your being required to sue in China cuts off any possibility of your recovering anything as against your China counterpart on the IP theft. See Enforcing US Judgments in China. Not Yet. If your Chinese counter-party knows you cannot ever recover against it in a lawsuit, you have just told them that they can steal your IP with impunity.
  3. The NDA will usually be in just English and that has its own inherent problems. See The Five Keys to A China Contract That Works.
  4. The NDA virtually never will have a contract damages provision or if it does, the amount will be so high as to nullify it. See China Contract Damages: More Art Than Science.

There are countless other reasons why it is critical you have an appropriate China NNN Agreement in place if you are serious about protecting your IP from China and one of our China IP lawyers explained one more of these by email to a client the other day when she explained the inherent difference between an NDA and an NNN Agreement:

This company wants to convert the NNN agreement we wrote for into a NDA based on abstract principles of trade secrecy law. Our NNN agreement is not a trade secrecy agreement. It is a contract that essentially says if XY or Z leak out, they will be responsible and they will owe you x dollars in damages. See On the Importance of Contract Damages in China Contracts.

Accordingly, you should reject virtually all of the changes requested by your Chinese counter-party.  They just don’t get it or they are trying to lure you into signing an agreement that will not protect your IP in China. The changes they are requesting are the opposite of what you want and need and it does not make sense to go through them item by item to explain. Your answer should be a simple no.

We have drafted close to one thousand NNN Agreements for our clients doing business in China and probably close to an additional thousand for our clients doing business in various other countries in Asia and elsewhere around the world and they virtually always get signed. China. We sometimes make adjustment based on legitimate concerns that the agreement will restrict the use of technology already owned by the receiving party. However, this agreement has already been revised to deal with those legitimate issues. Given this history, you should be wondering on what possible basis would this single entity have to demand a complete revision of the agreement. We think it is because they want you to sign a bad agreement (an NDA and not an NNN Agreement) so they can easily walk away with your IP.

If you want to protect your IP from China you need an appropriate China NNN Agreement or the appropriate NNN provisions in some other agreement (your manufacturing agreement, your licensing agreement, your distribution agreement, your JV agreement, your whatever agreement. Please don’t just use an NDA believing it is better than nothing because it isn’t. Oh, and by the way, pretty much everything stated above applies with at least equal force to just about every country in Asia as well.

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Incoming China FDI. Gone with the Wind.

If you are waiting for your Chinese investor to get your company promised investment funds any time soon, you are probably in for a long slog. Most companies, both private and public, do not care who provides their investment capital (as long as the investors are content being passive investors), and Chinese households have typically been lauded as excellent savers,  leaving money available to invest at home and abroad.

With my law firm having four West Coast offices (Los Angeles, Portland, San Francisco, and Seattle) we definitely get our fair share of work from U.S. companies in various stages of securing (or not) Chinese investment. In those deals we often hear something like the following: “The other owners tell me they have friends in China who can put in enough money into the company so they can buy me out. But they are having trouble getting their money out of China right now. Do you think they will be able to get their money from China to the U.S. in the next few weeks?” My response is usually something like “that is not likely to happen soon, and it may not be possible to accomplish even in a few months.” China’s government has a tight grip on its money (technically renminbi (人民币) means “the people’s money”, but the people can’t be bothered to look after their own money, right?). Even when times are good, China controls foreign currency leaving the country, especially U.S. dollars. But times are not good in China, despite recent reassurances from Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission. How do we know times are not good in China? There are a lot of smart people in the world who track where money flows and how that movement (or lack thereof) impacts our qualities of life. They are called macro (big picture) economists. These economists have noticed that (a) although China is encouraging foreign investment in its banking and insurance sectors, promising ownership of up to 100% by foreign investors, so far no one is biting, and (b) foreign lending institutions are loathe to provide capital to Chinese banks and industries, seeing economic risks in China everywhere they look.

Chinese would-be investors in U.S. ventures are finding it exceedingly difficult to get money out of China, even their allotted USD $50,000 in foreign currency each Chinese national is permitted to transfer out of China, according to China’s State Administration of Foreign Exchange. But in practice, such applications are being more closely scrutinized by China’s ever-present bureaucratic machine, and even China’s elites, like the former central bank adviser, Yu Yongding, are being denied access to foreign currency. That means your prospective Chinese investor or business partner (or customer who owes you money for your raw inputs, such as U.S. timber) may not be able to get you those U.S. dollars you have been waiting for any time soon, no matter how well connected they are.

Why is China holding onto U.S. dollars? China needs to maintain its foreign exchange reserves (largely held in dollars) for several reasons. One of the primary reasons is so China can continue to fund its global export machine that does business in U.S. dollars with the rest of the world. Chinese exporters buy their raw inputs in U.S. dollars, so China’s central bank needs to keep sufficient foreign exchange reserves to facilitate those transactions. A second reason is that to the extent China can keep U.S. dollars out of circulation, China can artificially keep its currency value low, which makes its exports more affordable to the U.S. and to the rest of the world. China holds more than $3 trillion in of its assets in a foreign currency, which equals approximately $2,142,000 per capita in China’s 1.4 billion population (in comparison, the U.S.’ $126 billion in foreign exchange reserves equals approximately $385 per capita in the U.S.’ 327 million population). China’s currency restrictions are not new. These restrictions are an integral part of China’s economic policies under which China wants to keep its yuan valuation at least seven times higher than the U.S. dollar. China can also use its foreign currency holdings to buy up yuan when others are trying to dump it, to keep the yuan from freefalling in foreign exchange markets due to concerns like a trade war or ongoing economic restrictions or sanctions.

To bring this discussion full circle, if your would-be business investors are Chinese companies or citizens or have money in Chinese bank accounts that they are having “a little trouble” getting to your U.S. bank account, you should not be making near-term plans that rely on their promised dollars. Chinese currency leaving for foreign markets is a form of capital flight to which China is keenly attuned and to which it will take strong measures, both overt (currency manipulation) and covert (denying individual foreign exchange transactions in Chinese banks, even when those transactions are in sync with Chinese law).

We recently had to deal with the above issues while representing a large cannabis company in California. The interesting thing about those deals is that they also implicate criminal laws in both China and the United States. Though China on the one hand makes a huge portion of the world’s vape products and other cannabis accessaries and is a leading exporter of CBD, both CBD and cannabis are illegal in China and those involved with it face harsh criminal penalties. Though all three states in which our law firm is located (Washington, Oregon, and California) have legalized cannabis, it remains illegal at the federal level. What all of this means for China-US cannnabis deals is that there are added risks, of which the parties are oftentimes completely unaware. By way of one example, if your international investor has already applied or wants to apply for a fast-track EB-5 visa path to U.S. citizenship, their investing your cannabis venture is a huge red flag that will derail their application process and impact their ability (if they are or become a green card holder) to become a naturalized citizen because they will have been involved with a controlled substance under U.S. federal law. If the potential investor’s immigration attorney is not aware of that minor detail, then you can do your investor a favor and let them know. For a primer on foreign investment in U.S. cannabis businesses, read this. Knowing China’s distaste for cannabis also means many Chinese cannabis investors very much want to maintain their privacy when investing in U.S. cannabis ventures, yet due to state transparency laws, accomplishing this is rarely easy and sometimes just not possible.

All this makes cannabis and China a fun mix for international cannabis lawyers, but most fail to find much humor in it.

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In yesterday’s Part 1 (of what is rapidly becoming a series) of Foreign Companies in China: What We are Seeing and Hearing NOW, we provided updates on what is happening in China relevant to foreign companies doing business in China or with China. The gist of that post was that many foreign companies that manufacture in China are leaving China, reducing their footprint in China, or looking to leave China or reduce their footprint there. Yet at the same time, foreign companies that sell products or services in China are forming WFOEs to go into China or if they are already there, they are growing their presence there, while at the same time, making sure that they are operating legally there.

We got two very interesting comments to that post, worthy of full responses. I will address the first comment today, and the other comment eventually. The first was the following:

If you actually have an increase in WOFE requests I have an FICE that I would be willing to sell cheap. My guess is all of my other friends who are leaving China with their businesses would be happy to sell theirs too. Most of them are just walking away though and not actually closing the business.

There are and will always be WFOEs in China looking to shut down and the number of these typically increases when times get difficult in China. The number of WFOEs closing during tough times is usually for a combination of two reasons: decreased economic opportunities and increasing compliance enforcement. In yesterday’s post I talked about how many of our clients are coming to us for what we call WFOE audits, which typically consist of our China lawyers doing some or all of the following:

  • Make sure their WFOE actually exists and is licensed to do what it is actually doing.
  • Make sure they have the proper entities and licenses to do business in every city in which it is doing business.
  • Make sure its trademarks and other IP have been filed in China.
  • Have us conduct an employer audit to make sure it is doing everything right on the employee side.
  • Make sure it is current with its taxes.
  • Review lease agreements.
  • Review contracts signed by the WFOE or by the parent company relating to China operations.
  • Due diligence on suppliers/manufacturers and distributors, retailers, and e-commerce platforms to make sure that those relationships do not violate home country (US or EU or Australian) laws and to make sure that those companies are financially sound.

If China is getting economically difficult for you and you are contemporaneously being hit with increasing regulations and increasing regulation enforcement, leaving is a logical choice and we are seeing that happening as well, but I forgot to mention that yesterday. Why did I forget to mention that? Because WFOEs leaving China is nothing new and we have not seen a massive uptick in that, with the possible exception of 1-2 person consulting WFOEs that had essentially stopped doing much if any business in China years ago. For the 101 on how to close a China WFOE, check out Shutting Down a China WFOE: Don’t Go There.

What about selling your WFOE rather than shutting it down. On the surface, this makes complete sense in that it allows you to make money by leaving China, rather than having to pay money to leave China. Unfortunately, for a whole host of reasons, it is extremely difficult to sell a WFOE, as we explained in Selling Your China WFOE: Yeah, That’s the Ticket:

The problem is that to buy a WFOE requires the buyer essentially want to do exactly what the seller has been approved to do. So for example, if I want to do a consulting business in Qingdao, I must buy a consulting business in Qingdao. And then I also have to make sure that the costs of my doing due diligence on the WFOE and the risks of buying into the liabilities and problems of the WFOE, do not outweigh the advantages of taking over a WFOE, as opposed to forming a new one.

It is indeed possible to sell a WFOE and our China M&A lawyers have been involved with a couple such sales and they are not difficult from a legal perspective, but they are usually difficult to justify from a business perspective. We sometimes see WFOE sales to employees (either expats or Chinese citizens or even combinations thereof) who want to see the WFOE keep going so they can hold onto their jobs. It is possible to sell a WFOE to a Chinese company or a Chinese citizen (and this would include to an employee) and then it converts to a Chinese domestic company. This too is not difficult legally, but such sales are rare because usually the employee knows exactly why the WFOE is closing and usually the employee can choose to essentially take over the WFOE after the foreign company has left, and do so “informally” and without any payment.

You can sell your WFOE to a foreign company looking to do business in China, but that too has many inherent difficulties, which we detailed in Buying And Selling China WFOE Shell Companies. Not In My Lifetime?

Those trying to sell their WFOEs usually tout them as liability free and therefore ready to go much faster and at a much lower price than forming a brand new WFOE For what it takes to form a WFOE in China, check out the following:

The above posts show that forming and registering a WFOE in China is a difficult and time consuming process but buying an existing WFOE is in most cases not much easier, if at all.

To quote from a previous post we did on selling your China WFOE:

The thing about off the shelf WFOEs is exactly that: they are off the shelf and not customized. And that is where all of the problems arise. Let’s take as an example a WFOE that someone tried to interest me in many months ago. That company was in the IT outsourcing business in a second tier city. So right there, its only real potential buyer is someone who is interested in doing IT outsourcing in that second tier city.  Because if the buyer of that WFOE is interested in doing anything other than IT outsourcing, it will need to petition the government to expand or change its business scope. Similarly, if the buyer is interested in doing IT outsourcing in some other city, it will need to petition the government to move its WFOE or it will need to set up a branch in that other city, and thereby have to maintain two offices. When you throw in the fact that anyone buying a WFOE will need to conduct due diligence on it to make sure it truly does not have liabilities of any kind (including, tax, employee, environmental, tort, etc.) you can quickly see why forming a WFOE is going to be safer and probably equally as fast and cheap as buying one. The biggest benefit in buying a shell WFOE would be speed, but it is going to be the rare instance where saving a few months will warrant the extra risk.

In the post, “How To Form a China WFOE. Scope Really Really Matters,” we discussed the importance of a WFOE having a proper scope:

BUT — and this is why I am writing this post now — if you under or overreach on the description of your business scope, you might find yourself in big trouble.  We are getting an increasing number of calls from American companies in trouble with the Chinese government for doing things in their business that they did not mention in the business scope section of their initial WFOE.

In some cases, the companies have admitted to us that they were never “really comfortable” with the business scope mentioned in their applications, but that the company they had used to form their WFOE had “pushed” them into it as it would “make things much easier.” In some cases, the scope of the business changed after the application was submitted and the company had failed to secure approval in advance for the change. And in some cases, the company probably would never have been approved at all had it been upfront and honest in its application. In nearly all instances, the companies had managed to secure local approval but were now in trouble with Beijing, which constantly is auditing these applications. In one instance, the local government went back and changed its mind, probably after conducting an audit of its own.

I cannot go into any more detail on these matters, but I can give this advice: applying for a WFOE in China involves a heck of a lot more than just filling out a form and getting approval. It does matter for what you get approved and you (or whomever you are using for your WFOE application) need to know China’s foreign investment catalog inside and out before applying. You then must tailor your application to meet both the requirements of the foreign investment catalog AND the reality of what you will be doing in China. A failure to comply on both fronts will lead to, at best, a rejection of your application and, at worst, being shut down months or years later.

The odds of a shell WFOE’s city and scope lining up perfectly with what is needed by potential WFOE buyers are low and we are not aware of any website that tries to match up WFOE sellers with potential WFOE buyers.

Steve Barru, a former China business blogger, wrote many years ago about trying to “get out of his China WFOE” [his blog is no more but because we previously quoted him here, his words on selling a China WFOE live on]

When Barru learned how difficult it would be for him to shut down his China WFOE, he sought to sell it, which too proved difficult:

Selling the company, even for next to nothing, quickly moved to the head of the line. But transferring the business license and my legal person status to the wannabe new owner involved far more than filling out a couple of forms.

It was the buyer who had to jump through the bureaucratic hoops. For all intents and purposes he went through the same process one goes through to establish a WFOE. With one key difference – he did not have to invest new capital in the company. The original US $70,000 in registered capital (that I had put in and had later managed, for the most part, to take out) was all that was required. Since registered capital for a WFOE had increased to US $200k by 2005, there were demands for additional investment, but rather convoluted negotiations eventually got around this obstacle. Fortunately, the buyer was located in Nanjing. The need to move the WFOE to a new locale would have been a deal breaker.

Eventually, after several months of discussions and chopping forms, all the questions about registered capital, business scope of the company, the good character of the new owner, and the license transfer had been answered and the sale was complete. The price probably covered my express mailing costs and bought me a couple of dinners. But I was out from under what had become an enormous, very time consuming headache.

The same holds true today.

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A number of our clients have been calling us nearly weekly of late for what they usually call “China briefings” or “China updates.” They mostly want to know what our China lawyers are hearing is happening to foreign companies in China. These calls usually consist of one of our China lawyers listing out the most recent things our firm is hearing about China (we have an entire Slack channel essentially dedicated to this) and then our client asking questions regarding some of the things they are hearing.

The below is a listing of many of the things we have recently been discussing:

1. a couple of clients have heard that Chinese police (from Beijing?) are going into foreign company offices (especially in Shanghai) and testing everyone for drug usage. They are cutting hair and sampling that and those who test positive are being immediately deported and told never to return to China. Cannabis stays in your hair for up to 90 days and many are getting booted out of the country for testing positive for weed. I keep hearing this is happening yet I have never been able to confirm it. I hear this one a lot from Americans who once lived in China and they are hearing it from their American friends who still live in China, but none of our clients have ever mentioned it and I have never heard it directly from anyone who was involved in such a raid. Anyone else know anything about this.

2. Will China kick out American companies that are doing business in China? My answer to this is always no. If China were going to kick out American companies doing business in China it likely would have done that a long time ago and it hasn’t, largely because it does not want to kick out the jobs and the technology those companies contribute to China. I am always getting asked this question but I have not heard of one instance where it has happened.

3. What is going on with the trade talks? My response is that everyone keeps talking about the upcoming meeting between Presidents Xi and Trump as though their meeting is a done deal. In my view, there is only about a 50% chance there will be a meeting and then well under a 50% chance that meeting will result in anything at all. We are telling our clients now what we have been telling them pretty much since the US-China trade war started: this is more than a trade war. If it were just a trade war, China would have ordered more soybeans and we would be done with it. It is a technological war and it is a geopolitical war and therefore the odds of their being resolution are not good. On top of that, even if there is some resolution on tariffs, many other things (like the Huawei ban and various trade duties) will keep happening.  Companies should be planning accordingly.

4. Are foreign companies leaving China?  Foreign companies are not leaving China, at least as far as we can tell. I am not aware of a single client of ours who has left China and, in fact, we are busier than we’ve ever been in helping clients form WFOEs to go into China. Why NOW Is a Good Time to Double Down on Doing Business in China.

5. Are foreign companies moving their production outside China? Absolutely they are. All sorts of companies are and all sorts of our clients are. Some are telling their Chinese manufacturers that they need to set up factories elsewhere and some of these Chinese manufacturers have done so — mostly in Vietnam, Thailand, Malaysia, and the Philipines. Some are planning to reduce production in their China factories as they work to set up new factories outside China — mostly in Thailand and Mexico. Some have simply shifted their contract manufacturing from China to Vietnam or Thailand or Malaysia.

6. What about product pricing? What are Chinese manufacturers doing on this? We are seeing everything. We have some clients who are being refused any discount whatsoever from their Chinese suppliers and we have other clients who are getting big discounts from their suppliers and we have everything in between. Most are in between. See US-China Tariff Updates: What You Can (and Should NOT) do NOW.

6. What is happening on the tech side? Everyone is super cautious, which is exactly how the Trump administration wants it. The deals have dried up. Plain and simple. Last year our M&A lawyers must have handled a half dozen transactions (that closed) involving Chinese companies buying American or European companies or investing in them. This year I cannot think of even one. Chinese foreign investment into the United States and Europe has plunged. Technology licensing deals are way down as well.

7. Is China cracking down on foreign companies? What about China’s list of unreliable companies? Whenever China has problems with a foreign country or with its own economy (both of which are happening in spades right now), it starts cracking down on foreign companies. That is happening right now and we are seeing it with all the foreign companies that are coming to us with major compliance problems. Again though, this sort of thing is nothing new and this sort of thing can almost always be avoided by making sure both you and your company are in full compliance with Chinese laws. See Want to Keep Your Business in China? Do These Things NOW. A number of our clients have asked us to audit what they are doing in China to “make sure they are doing what they should be doing.”  We typically suggest they have us do some or all of the following:

  • Make sure their WFOE actually exists and is licensed to do what it is actually doing.
  • Make sure they have the proper entities and licenses to do business in every city in which it is doing business.
  • Make sure its trademarks and other IP have been filed in China.
  • Have us conduct an employer audit to make sure it is doing everything right on the employee side.
  • Make sure it is current with its taxes.
  • Review lease agreements.
  • Review contracts signed by the WFOE or by the parent company relating to China operations.
  • Due diligence on suppliers/manufacturers and distributors, retailers, and e-commerce platforms to make sure that those relationships do not violate home country (US or EU or Australian) laws and to make sure that those companies are financially sound.

What are you seeing out there?

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Same. Same. Same. Same. 

I am often asked why I blog. One of the reasons I always give is that I learn so much from it. One of my favorite blog learning devices is asking super-smart people to guest blog on here, especially when their expertise is different from that of the blogging lawyers at my firm.

Way back in 2014, we had Lucas Blaustein write about US-China agricultural relations. Lucas is now in a high level agricultural position with the US Foreign Agricultural Service, but back then he was the Container/Feed Ingredient Manager for a global transportation company focused on food with extensive China experience, fluency in spoken and written Mandarin and a Masters in Agribusiness.

His post, entitled Hit Us Where It Hurts: China’s Ban on U.S. Agricultural Products Grows, focused on how China was improperly banning US corn products so as to favor its own corn producers:

Since China’s admittance to the World Trade Organization (WTO), China and the United States have increasingly traded their comparative advantages. Daily, Chinese made iPads, Lenovo computers, Nike sneakers, and other material trappings of American consumerism arrive in U.S. ports, where they are unloaded and then returned filled with U.S. grain products like soybeans and corn. But in November 2013 the system began to break down, as corn exports to China came to a halt.

What caused this halt was the discovery by China’s Inspection and Quarantine Services (CIQS) of an unapproved genetically modified corn varietal called MIR-162 in imported shipments. Import permits began to be denied, and US corn exports to China gradually decreased to nothing. Grain merchandisers and U.S. farmers were horrified, as the fastest growing market for U.S. corn closed its doors.

Agribusiness companies and Chinese importers were quick to react, replacing corn grain as the number one U.S. export to China with a corn based ethanol byproduct called distiller dried grain with solubles (DDGs). For a time it seemed that American grain merchandisers had found a solution to China’s ban on U.S. corn with DDGs, but this “solution” was short-lived. In the spring of this year China stopped returning import permits for DDGs.  After months of confusion, the U.S. Embassy in Beijing on July 24 received a short message stating that “U.S. DDGs imports must now be tested at origination for the unapproved gene MIR-162.” In the space of a day, traded corn prices dropped by more than half.

Shortly thereafter the USDA issued a statement asserting that there is no reliable, affordable method of testing for MIR-162 in DDGs, nor is there even a regulatory body in the United States with the manpower or funding to conduct such a test, even if one existed. In other words, what China did on July 24 was to ban importation of all U.S. corn based products.

Why did China do this?

Sino-U.S. relations are at one of their lowest points since before China’s period of great opening up. In light of recent events involving Apple, Microsoft, GSK, Cisco, KFC, Starbucks and many other American businesses in China, it would not be out of bounds to view China’s ban on U.S. corn imports as punishment for worsening relations. The National Grain and Feed Association (NGFA) estimates that China’s ban has cost U.S. farmers and agribusiness firms nearly three billion dollars. U.S. farmers could be hit especially hard during the upcoming year, with larger than average corn yields anticipated, and more new unapproved GMO varietals in the ground.

But what is often lost from the punitive argument is the Chinese side of this story.

*      *      *      *

China knows GMO technology is critical to increasing crop yields, so investment in GMO technology has surged, despite public fears over negative health effects. Chinese officials are wary of becoming overly reliant on genetically modified seeds from the Western world. Within the last six months eight Chinese Americans and nationals have been arrested on accusations of corporate espionage and theft of American seeds. MIR-162 grain imports may not be allowed into China, but China desperately wants access to the technology that produced the MIR-162 strain.

With lower input costs and better technology, world corn prices have been lower than China’s domestic corn prices for years. For this reason, Chinese companies have imported significant amounts of corn. The easiest way for China to protect local farmers is to force the purchasing of Chinese corn by limiting the amount of foreign corn that enters the Chinese market.

Protection for local farmers, fear of reliance on foreign GMOs, and investments in agriculture are all part of China’s broader food security strategy. Banning U.S. corn for food security reasons is probably as strong an argument for why China banned U.S. corn as punishment for worsening relations.

With Sino-U.S. relations still very poor, another record corn crop this year in China, as well as Ukrainian, Brazilian, and Argentinian corn imports approved, no matter which reason you favor for the ban on American corn products, there is little reason to believe China will lift that import ban any time soon Every day it becomes more likely that only a significant and public response from the United States government, or litigation in the World Trade Organization, will open China back up to US corn product imports.

But if all Lucas had done was to write about China blocking foreign products to secure its own competitive advantages, I would not be re-running his post today. Sure, that is relevant in that a huge part of the US-China trade dispute stems from actions just like these, but China has done enough things during the last five years that there is no great need to focus on how ruthlessly it treated America’s corn farmers back then.

No, what has caused me to re-run Lucas’s post is a comment he left in response to a comment left by another of our readers. In that comment, Lucas essentially lays out what has given rise to the US-China trade war we have today:

If the United States desired, it would be much easier for us to cripple the Chinese economy, than for the Chinese to cripple ours. While you commonly hear, “everything is made in China,” few of the staple items the U.S. consumes are actually made in China, and most items that are actually necessary to our society can be manufactured elsewhere. Think food, fuel, transportation, weapons… (all are of these are domestic or ally nation industries).

China is still an export driven economy, with no other major export markets for its goods besides the EU and North America. Were the United States to put in place a ban on any number of China sourced items it would cause immediate harm, and potential civil instability in the People’s Republic. The easiest way for the United States to inflict harm on the Chinese economy, would be to ban Chinese companies and individuals from listing on the stock market.

Few in the United States see economic punishment as a constructive step. Engagement is usually the best way to solve these kinds of difficult problems. However, engagement has been so far unsuccessful between the current U.S. and Chinese administration.

What the United States must be careful of economically, is providing China with too much access to our market sectors in the hope that China will reciprocate. Two excellent and very recent agricultural examples of the United States opening up or approving a business opportunity to Chinese companies are: 1) the Smithfield acquisition by Shuanghui; and 2) the approval of Chinese chicken processing plants. Both were approved in the hopes of China relieving some of its restrictions on U.S. agricultural products. Sadly, neither the Smithfield or chicken import approval has resulted in similar market openings. Now American chicken companies have been exposed to Chinese competition, with major protein imports to China like beef and pork still mostly banned.

Telling was what one of the congressmen had to say about the Chinese acquisition of Shuanghui, “we are allowing a Chinese company to do in America, what an America company would not be allowed to do in China.”

Plus ça changeplus c’est la même chose.

Brief sidenote: Some of the international litigators at my law firm had a case a few years ago against Smithfield Farms, involving millions of dollars of pork that were bound for Russia but became subject to US trade sanctions against Russia. What so struck our lawyers was how Smithfield Farms, which had once been a bulwark of an American food/farm company, acted in so many ways like a Chinese company in China. Not necessarily a negative thing, but definitely unusual.

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