The Law Offices of Justin J. Shrenger, A Professional Corporation (JJS APC), was established in 1994 and has continuously been involved in the provision of high-quality legal services for companies doing business in China.
Once a business decides their next endeavor is the Chinese market, the next logical step is deciding how to do it. For some, the best course is to set up a separate business organization in China. Below, we outline the most common legal structures for foreign-invested business in China.
What legal structure works best for a business in China?
China’s laws on corporations recognize two types of companies: Limited Liability Companies (LLCs) and Joint Stock Limited Companies. Joint stock companies can sell shares to raise capital, but they are subject to more compliance requirements than LLCs.
Companies with a foreign investment element often choose to organize as an LLC, as they offer several advantages:
Since an LLC is, for legal purposes, a “person,” it can own property and claim ownership of intellectual property assets. This can make navigating China's intellectual property regulations a little easier.
Fewer regulatory obstacles
LLC registration in China is generally easier than that of a Joint Stock Limited Company. Plus, there are fewer compliance requirements for LLCs.
Just like American LLCs, shareholders and owners of an LLC in China can protect their personal assets from liabilities or debts of the company.
Do you need to form a WFOE?
Many looking to do business in China have probably heard of a Wholly Foreign Owned Enterprise. In the simplest sense, this is an LLC owned entirely by foreign investors.
For some business ventures, this step is necessary to do business safely in China. One situation where a WFOE is legally necessary is if your business plans to have employees in China. However, the process is complicated and expensive, and business owners should consult with an attorney experienced in Chinese business practices before forming one.
Made in China 2025 is a ten-year plan aimed at quickly updating China’s manufacturing base to more high-tech products. When it was introduced in 2015, it drew a lot of attention by global leaders – especially in the United States.
Some saw it as a veiled method of obtaining American intellectual property. In light of this criticism, the Chinese government began to downplay the importance of the plan. However, the country continues working towards a shift in manufacturing that will reduce its dependence on foreign technology.
A shift in manufacturing
One of the primary goals of China 2025 is to promote high-tech manufacturing. For decades, a large portion of China’s economy focused on mining, energy extraction, and manufacturing consumer goods like clothing and footwear. With Made in China 2025, the Chinese government aims to change that focus on expanding tech sectors, such as:
Next generation telecom equipment
China 2025 provides direct subsidies to companies focused on next generation manufacturing, as well as encourages Chinese companies to invest in foreign firms making these products.
Reducing dependence on foreign tech
The manufacture of semiconductors is especially vital to the plan, as it is an area where China’s market demand far outstrips its supply. China’s economy accounts for 60% of global demand for semiconductors, but only 13% of the supply. Under the plan, China aims to be 70% self-sufficient in high-tech industries by 2025.
Other global economic powers have pursued similar plans in the past, such as Germany’s Industry 4.0 Plan. As trade talks continue between the United States and China, the program will likely evolve. The name might change, but China’s focus on revitalizing its manufacturing sector for new technologies seems to be here to stay.
A new study released this week found that, in light of trade tensions between the two countries, Chinese consumers are buying fewer products from the United States. The survey, released by London-based firm Brunswick, polled 1,000 American consumers and 1,000 from China to find out how the ongoing “trade war” was impacting buying habits.
Continued tensions risk U.S. business’s bottom line
Brunswick’s report found that while 77% of Chinese consumers often buy American goods, 56% have begun to avoid buying U.S.-made products to show their support for China. Moreover, 41% reported buying less because of tariff-related price hikes on American products. Plus, 68% of respondents in China said their view of American companies has grown more cynical as a result of the trade dispute between the two countries.
This report comes as China and the U.S. have imposed tariffs of up to 25% on billions of dollars worth of products over the last year. And although government officials from both sides continue working toward a solution, the survey finds that consumers believe they will pay the price.
Consumers in both countries believe they are impacted most
Respondents in both countries reported noticing increased prices on household goods since tariffs on American and Chinese goods increased. In addition, the majority of consumers surveyed in both countries thought consumers suffer the most in light of trade tensions (over businesses and government entities).
However, most of the people surveyed agree that achieving a trade deal between China and the United States is essential for both economies. In fact, 86% of American consumers and 97% of Chinese consumers stated that addressing bilateral trade is a priority.
China’s new foreign investment law, which takes effect January 1, 2020, aims to level the playing field between domestic and foreign investors in the country. Delegates at the National People’s Congress (NPC) voted overwhelmingly in favor of the measure in March - just three months after it was introduced. Delegates proposed another version of the law back in 2015.
Important aspects of China’s Foreign Investment Law include:
Some protection for intellectual property, with room for interpretation
Article 22 of the new law states that China will protect the “intellectual property rights of foreign investors and foreign-invested enterprises according to the law.” This is essentially the same as previous laws, including WTO agreements on intellectual property.
However, the text of the intellectual property provision does not expressly prohibit forced technology transfers, a long-standing thorn in many foreign business’s sides. In fact, it seems to leave Chinese firms with the option to demand a technology transfer by stating: “The conditions for technological cooperation in the course of foreign investment are to be negotiated by the various parties to the investment.”
The Foreign Investment Law also allows China to place investments the government deems to influence national security under “security review.” Any decision made by the State regarding these investments is final.
Some gaps remain
Several provisions included in the original proposal did not appear in the final version, leading some to argue the law does not go far enough to protect foreign investors. Others say that because the new law removes old protections for foreign investors, they will, at best, be treated the same as domestic investors; or in some cases, worse.
A World Trade Organization dispute panel announced Friday that the intellectual property case between the United States and China will now be on hold until December 31. According to Reuters, the United States requested the hold on the case - which challenged China’s approach to intellectual property - but did not disclose its reasons for the request.
The clash over intellectual property theft
This dispute traces its roots back to last year when the United States filed a complaint with the WTO alleging that China “appears to be breaking WTO rules by denying foreign patent holders, including United States companies, basic patent rights to stop a Chinese entity from using the technology after a licensing contract ends.”
The U.S. argued that several of China’s intellectual property laws violate the WTO’s Agreement on Trade-Related Aspects of Intellectual Property Rights (also known as the TRIPS Agreement). Among other things, the TRIPS agreement prohibits WTO members from treating foreign entities less favorably than domestic ones concerning intellectual property. The U.S. pointed to China's forced technology transfers as a method of favoring domestic entities over foreign ones.
Is a thaw in intellectual property disputes coming?
As we covered in a previous post, one of the topics over which the United States and China have long quarreled is China’s habit of forcing foreign entities to trade their technology rights for access to the Chinese market. However, perhaps between new legislation in China and the United States pressing “pause” on its WTO complaint, intellectual property disputes between the two countries are headed for resolution.
When an American business encounters a dispute with a Chinese company, the procedures for resolving the dispute are different than if they simply wanted to sue another organization in the U.S. Today, we cover the basics of resolving disputes in China.
The basic options for dispute resolution in China are the same as we find here in the United States: negotiate, arbitrate, or litigate. Below, we focus on arbitration and litigation in China.
The China International Economic and Trade Arbitration Commission
The most popular venue for disputes with Chinese businesses, the CIETAC provides “foreign-related” arbitration rules for cases where one company does not operate in China. If American and Chinese businesses enter into a contractual relationship, they can designate CEITAC as the venue for disputes. They can also specify the nationality of the members of the arbitration panel if they wish.
Under the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards, arbitration awards in one country are enforceable in other signatory states.
Litigation in Chinese courts
In the past, many observers have lamented the state of China’s judicial system. However, the implementation of China’s new International Commercial Court may signal a move toward better litigation in the country. Originally intended to only deal with “belt and road” cases, the International Commercial court can now take on disputes involving large foreign businesses.
Disputes in China can also be resolved through mediation, rather than going to trial, similarly to the system in the United States. If a business finds itself facing a dispute in China, it often helps to consult an attorney experienced in the laws of both systems.
Many business look to licensing deals with Chinese companies as a low-cost way to enter the Asian market. However, while an agreement to license your product in China can provide many benefits there are a few important differences between the U.S. and China that come into play.
If a business is considering a licensing deal in China, here are a few tips to keep in mind during negotiations:
Register any applicable trademarks, patents, and copyrights
Ensure the intellectual property assets your licensee in China would be allowed to use are registered in China. Ideally, have your company and counsel do the registration work, to avoid any issues that might arise from having the licensee register for you.
Know what type of entity you are dealing with
Over the last several years, it has become more and more common for Chinese firms to offer American businesses an ownership stake in the company in exchange for a licensing deal. However, in some cases, such a stake cannot actually be granted.
Wait to sign the Letter of Agreement
Unlike in the United States, the Chinese legal system can enforce a Letter of Agreement (LOA) or Memorandum of Understanding (MOU) as a valid contract if it is signed by both parties. Do not sign one of these documents until you can have it reviewed by counsel. Alternatively, you may be able to include language in the letter making it unenforceable.
These are just a few of the important considerations in a U.S./China licensing deal. An attorney well-versed in the interplay between laws in China and the United States can provide guidance on individual deals.
In many business decisions, you can look at your market competition, location and customer demand to determine the probability of your success. But when you consider starting a business in China, there is much more at stake.
Many American companies manufacture their products in China because of the cost savings. But considering the current political climate, which will potentially affect trade between the United States and China, you may want to think about how new tariffs may impact a business.
Tariffs could have a far-reaching effect on consumers and business owners
In addition to potential intellectual property concerns, many businesses fear increased costs that accompany tariffs. But if you choose to develop products in China, there are two things you must consider when deciding whether the time is right:
American budgets. Many people do not think about a product’s origin when they make purchasing decisions. However, with tariffs increasing, the price of everything from food items to toiletries, clothing to aluminum, Americans may need to tighten their budgets, thereby reducing the number of purchases made.
Chinese decision making. Some might suggest that the Chinese economy could decline due, in part, to concerns over intellectual property rights. And trade negotiations could force the Chinese government to become more transparent in the subsidies of their national businesses.
Ultimately, both countries may experience temporary setbacks due to the increase of trade tariffs, so you would be wise to consider whether your business would perform well in China at this time.
However, as negotiations balance out and tensions ease, it is possible that more doors will open for Americans wishing to form business opportunities in China.
A survey released last week revealed that American companies are facing backlash in China over continuing trade disputes between the two countries. Less than two weeks after the U.S. increased tariffs on Chinese imports, nearly half of members of the American Chamber of Commerce in China reported facing retaliatory measures by the Chinese government.
American businesses report adverse treatment in China due to tariffs
According to a report by the Financial Times, many American-based businesses are experiencing retaliation in China. Forty-seven percent of members of the American Chamber of Commerce in China and its Shanghai equivalent said that increased tariffs were not the only consequence they saw in the ongoing dispute.
Some of the impacts reported include:
Slower customs clearance
Increased numbers of inspections
Delayed license approvals
As trade talks between the U.S. and China continue to stall, American companies will likely have to make some difficult decisions in the weeks and months ahead.
Businesses faced with tough choices
One-third of the 239 American companies in the survey said they are considering canceling or putting off investments in China. Meanwhile, almost 75% said tariffs were hurting their ability to compete in China. With no new trade talks currently scheduled, it seems conditions are not likely to improve for American businesses in the Chinese market any time soon.
Those doing business in China can benefit from legal counsel experienced in the legal systems of both countries. Whether their concerns relate to intellectual property theft, negotiating contracts, or litigation between international companies, a well-rounded perspective can lead to better results.
Senator Josh Hawley (R-Mo.) introduced a bill yesterday aimed at curbing intellectual property theft and unfair trade practices in China. If passed, the China Technology Transfer Control Act would place export controls on technology and intellectual property “important to the national interest of the United States.”
In light of continued trade tensions between the U.S. and China, this new legislation is worth a second look.
What qualifies as “national interest technology?”
The proposed law includes technology or intellectual property assets that:
Would “make a significant contribution” to China’s military that would undermine national security in the United States
Are necessary to protect the U.S. economy from the “excessive drain of scarce materials” and reduce inflation caused by demand from China
Are used by the Chinese government to carry out human rights violations
In a statement on the bill, Senator Hawley noted that the proposed regulation is “an important step toward keeping American technology out of the hands of the Chinese government and its military.”
The China Technology Transfer Control Act would place core technologies in demand by the Chinese government - including robotics, aerospace and marine technology, artificial intelligence, and semiconductors – on the Department of Commerce’s export control list. To export these products to China, companies will have to acquire export licenses.
As trade rules in both China and the United States develop, businesses dealing in tech products will likely need the guidance of an attorney familiar with both sides. A misstep could spell serious trouble for companies in both economies.