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Ten Additional Useful Things For Businesses to Know About China
A couple of years ago, I wrote an article entitled “Ten Useful Things for Small Businesses to Know about China.” That article was sufficiently popular that repeatedly I have been asked by clients to either update that list, or provide an additional list of ten. As the prior article was more about culture, history and business conduct (and therefore probably does not require much of an update), I have chosen to provide an additional “list of ten,” with more focus on legal processes and substance than in the prior piece, with the qualification that the general business climate in China, as well as the laws there, are constantly changing, and at a pace that is actually accelerating. But as I review these “additional ten items,” I will now highlight what I see as the common thread throughout: you must plan things very carefully, with experienced consultants, legal counsel and experts, in advance of your business dealings in China.
1. Protect Your Brand in China. Intellectual property protection in China should begin by “zeroing in” on compliance with China’s trademark laws, which are very different from those in the United States (and many other Western countries). China is a “first to file,” jurisdiction, so your prior use (and registration) of a trademark in other jurisdictions, or even your prior use of a foreign registered trademark in China, is generally less important than being the first party actually to register the trademark in China (in Beijing, with the Patent and Trademark Office there). Unlike some other “first to file” jurisdictions, China recognizes existing trademarks registered outside of China only in very limited instances: that is, generally only where the mark involves a well-known brand (in China). It is very dangerous to rely on that provision, as the list of well-known, unregistered foreign brands in China seems to be very short (if it even exists!) Essentially, if you are planning to have products manufactured or assembled in China, or to sell products into or distribute them within or even just through China, you should be filing for trademark registration in China as soon as practically possible.
Your trademark registrations should also be filed both in Chinese (this is essential) and in English (or other applicable foreign language). Businesses are cautioned to be careful in determining the Chinese names for their products and their companies, as some Western companies have notoriously fallen into traps when they have attempted to utilize Chinese names that sounded like their English (or French, German, etc.) names. The recommendation is to find a Chinese name that has a positive (and hopefully, somewhat related) meaning with respect to your product or company, and also that may sound “somewhat” like the English name for your product or company. But be warned that, in my experience, a Chinese name may not sound at all similar to an English name to most people from the West, despite that it may sound very close to the English name to people who are from or in China. So this is an area that could require some forethought and experimentation!
Before doing business in China you must develop and implement a general intellectual property promotion and protection “strategy” and plan. This should include not just the early registration procedures discussed above, but also ongoing plans for protecting your intellectual property (and product integrity) going forward, including monitoring and dealing with potential competition, piracy of brands, etc. All of this can be most effectively minimized (some things may not be entirely avoided) with appropriate planning and an appreciation for the “landscape” – otherwise, the costs of trying to deal with serious problems after they have already occurred can be immense, in addition to the costs of repairing the damages that already may have been caused.
2. Forming Entities For, and Activities by Foreign Businesses in China. Foreign businesses are generally required to create an entity in China in order to carry on most business activities within that country. Traditionally, this has been through the establishment of either a representative office (which now has very limited value or utility, as discussed below), a wholly foreign owned entity (popularly known as a WFOE, which is generally pronounced as a “woofy”) or some form of equity joint venture.
Representative offices are generally disfavored by Chinese law at this time. Representative offices are not allowed to generate profits in China, and therefore may only carry on very limited business activities, along the lines of a promotional office (one common example might be a promotional office for a foreign city or country that may exist to inspire would-be tourists to come to visit that city or country). If a representative office is found to be carrying on more business activities than are permitted, not only is it likely to be shut down, but there is also a clear likelihood that numerous penalties will be imposed.
By establishing a WFOE, which can include corporations, limited liability companies, and other similar forms of entities with which Western businesses are generally acquainted, a foreign business can not only establish a proper “beachhead” in China, but can also carry on business and earn profits there. However, the scope of what sort of business is to be carried out by the WFOE must be narrowly stated (or else it will never be approved), and once formed, the entity cannot then easily expand the scope of its business activities. There are also capitalization requirements for new entities, which are determined on the basis of what types of activities are to be conducted, where the WFOE is to be located, the projected size of the entity, and similar factors. In addition, there are restrictions on activities by certain licensed foreign professionals, who may be prohibited from obtaining a professional license for a WFOE, and instead may have to locate or otherwise “incubate” a domestic Chinese entity and then joint venture with that entity (again, in compliance with applicable regulations), in order to have a domestic entity that can then be licensed to carry on business in China. These are just some of the reasons why the scope of the intended business is so critical in establishing a WFOE.
With respect to joint ventures, they have gone from being very much in vogue, to being less popular, to regaining popularity (and each such “phase” has generally caused “ripple effects” among foreign businesses planning to go to China). In essence, a successful equity joint venture requires that a foreign business must find a solid and trustworthy joint venture partner in China (reliable due diligence is important), and usually a foreign business must enter into the joint venture by first establishing a WFOE in China, to joint venture with the chosen Chinese entity (by the two parties’ forming a new domestic entity, in which each will own equity, upon contributing capital). Often, foreign businesses should even consider creating a new entity to own its WFOE, to add an extra protective tier for purposes of limited liability (and any number of other considerations, including in the event of a need to shut down the business in the future).
3. Picking Your Locations. China is an extraordinarily large and diverse country. Just as (for example) one would be unlikely to locate in America’s heartland (as opposed to either of its coasts) for a business that will be reliant on sea transportation of or for its parts, or for distribution of its products to overseas buyers, a foreign business should carefully consider where it wants to locate or do business in China. Energy costs for transportation (and for operations) can be very high, and the costs of real estate leasing will vary dramatically for locations. Similarly, labor costs will fluctuate, as will the types of labor available (skilled vs. unskilled, etc.). See Section 6, below.
One approach is to seek proximity with others in the same industry in which your business will be engaged. Working with consultants or similar professionals, a foreign business can determine which regions and cities are most convenient and may in fact be somewhat “dedicated” to servicing businesses in your industry in China. Another consideration is whether and on what scale the business will require real estate facilities in China, and for what purposes. Businesses often don’t realize that the rental cost of real estate in, for example, Shanghai and Beijing is commensurate with the cost of real estate rentals in major cities such as New York, London or Tokyo. For that matter, as supply also dictates part of the formula for what is available and at what cost, businesses may decide to avoid a “follow the leader” attitude and seek to locate in an area that is both affordable and convenient for them and their businesses. High tech businesses might look to educational centers, science and industrial parks, special technology zones and similar developments, as it may find tax and other incentives to move there, including skilled labor forces, and that other requirements for their products may be readily satisfied there.
Finally, as China currently has approximately 160 cities of more than one million people, there may be new cities or industrial or commercial zones and sites suitable for your desired needs popping up in China all the time. This is something that is constantly changing, so what may have been a “perfect location” in a study that was conducted in, say, 2006, may now be inadequate or less than perfect for you.
4. The Importance of Real and Enforceable Contracts. Businesses should understand that before they enter into relationships with businesses in China, or even if they are already in a relationship there at this time, Chinese law tends to require formal, written contracts for transactions. This is different from how business may be conducted in the West, where ongoing relations between, for example, a purchaser and a supplier, with repeated purchases of products at a certain price, etc., will often be deemed to form a contract for legal purposes. In China, courts are unlikely to find that such behavior creates a binding contract, even if there are emails or bills of lading and other informal paper trails. Virtually all lawyers in China report that the first question that arises in a court or an arbitration proceeding, in any commercial dispute, is “where is the signed master contract, and what does it say?”
Just as important as having a proper written contract, those same contracts must also be enforceable in China. Common stories are often repeated about how the managers of Western businesses may be celebrating at their five-star hotels in a Chinese city, congratulating themselves on their good fortune in having negotiated and obtained counter-signatures on very demanding and restrictive contracts that are in English, consent to jurisdiction in non-Chinese courts, etc. But at the very same time, their Chinese counterparts may well be celebrating in another part of the same city, and laughing at the fact that they know that they have just signed a contract that is not able to be enforced in China, and therefore effectively they are not going to be subject to any legal restrictions or prohibitions. As a consequence, you should always attempt to start with a contract that is in a form that can and will be enforced in China against the other party, and be sure that it has appropriate “teeth” (and despite a general misguided foreign belief that China must be lawless, this can usually be done, under Chinese law) in order to penalize the Chinese counterparties if they breach the contract in any manner that has material consequences for you. This can all be negotiated, but (not surprisingly) it will usually take much more serious and patient negotiation skills than ever would have been needed to get a Chinese counterparty to sign a “biased for the foreigners, but clearly unenforceable” contract that might otherwise have been put before them.
5. The Costs of Doing Business. Doing business in China is a strategic decision, and as such, requires forethought, energy and expense. Foreign companies that try to “dip a toe” into China rarely emerge with the levels of success that might otherwise have been available to them. Businesses should treat the decision to do business in China with the same degree of seriousness as a decision to make a fundamental, long-term expansion into any new overseas market, or into a new industry, and also appreciate that the move should also be made with sufficient available resources that would be commensurate with or for any such strategic decisions. If this requires more time or money than your business is willing to devote, then you should assess how seriously committed you are to this strategic move.
Labor costs in China are going up dramatically, as are restrictions under applicable labor and employment laws (see Section 6 below). When coupled with changes to (essentially, the dismantling of nearly all of) the once-favorable-to-foreigners tax laws in China over the past few years, such increases in labor costs have led to an increase in the cost of many of the products in China. In addition, real estate costs continue to increase, energy costs in China are expensive (as such may apply equally to shipping, operation and production costs in general—on a comparison basis, they far exceed the costs in the U.S.), and the Chinese RMB currency (despite the government’s careful controls) is still slowly and surely appreciating against the U.S. Dollar and other foreign currencies (and most estimate that the Chinese currency exchange rates will continue to rise for the foreseeable future). As a result, China no longer offers such outrageously cheap product prices that businesses can still afford to run over to China only partially prepared, and simply buy products without having a solid plan in place.
In the past, many foreign businesses bought products in China through “middlemen” (trading companies), without much concern for the fact that the trading companies were taking extra money above what the manufacturers were receiving, as the prices were still so low that it did not seem to make much difference. Now, it really pays for a foreign business to be sure that it is buying directly from the actual manufacturers in China, not only to get the lowest prices, but also to have better warranties, as well as direct control over product quality and delivery (many have now learned from experience about such problems), and also to maintain better control over their company’s IP and brands. This also will enable foreign businesses to have more consistent business relationships with the real suppliers, and over time they should be able to enhance those relationships, in order to renegotiate if and as their orders increase--and if the foreign businesses already have successful WFOEs in place, they might also be in a position to arrange to pay for orders in RMB, to minimize the currency exchange risks.
6. China’s Employment Laws. Mainland China now has stringent employment laws and regulations that generally do not allow for “at will” employment (terminations of employees can be especially thorny), and usually will require written employment contracts. The employment regulations are detailed, and although many businesses might not be in compliance, as cautioned elsewhere in this article, the government’s failure to enforce the laws or regulations in one or more instances does not imply that strict legal compliance (especially by a foreign-owned entity) will not be deemed to be mandatory now or in the future. Failure to comply with some of the employment laws and regulations can expose a business to heavy monetary penalties, and (under recent Chinese laws) in certain circumstances, jail sentences for its managers or owners. In addition, salaries have been increasing dramatically, on a national basis, in China over the past several years (with salaries in Shanghai, Beijing, Shenzhen and other “first tier cities” having jumped the highest). Most expect that general salaries will continue to increase, on a national basis, for some time.
7. China’s Domestic Markets. The domestic markets in China are now an enormous enticement for foreign businesses of all sizes. As the middle class in China grows (and grows and grows—very soon it is expected to exceed the number of middle class consumers in the U.S.), and the infrastructure is steadily improved, the seemingly ready market for Western goods, and especially Western brands, shines like a beacon. The first shrill note is always one of caution—consumer patterns in China, as well as the means of distributing and selling products into the Chinese markets, advertizing, shipping and storage, are all tricky to understand (much less to master)--they often will vary widely by location, and of course everything is always in flux. What sells in Shanghai may be entirely unpopular in other regions, or a business may learn (sometimes too late) that it had been relying on past sales volume statistics that were tied to national holidays or other isolated occurrences, and in fact that “regular product sales” are much lower or more stratified. Again, businesses need to develop sales plans, with channels for goal and method assessment, and implementation of corrective plans. But the potential numbers really are enormous, and already there are some Western “luxury goods” with more voluminous retail sales (and at higher prices) in China than in any single Western country (including the United States).
8. What is “Guanxi”? This term (pronounced “gwahn-SHEE”) is often used by a lot by foreigners, and also by Chinese hoping to entice them. Loosely, it means to have connections or otherwise be networked, as in “Person X knows many people in high places. He or she has great guanxi, and will be very valuable to your business.” Western businesses are often quite convinced that one or more individuals who claim to have many friends in government or business circles will be able to lead them in a direct beeline to the riches in China. Although true guanxi can be very valuable for a new venture in China, it is more elusive, and usually it takes a form that is more subtle than people who openly brag to foreign businesspeople about their networks of friends. On the governmental side, a person may be friends with some of the local cadres, which may be (although a “multilayered” dose of skepticism may be a useful starting point!) of some utility to your business, but even if it appears to have some validity, there is a possibility that it still may do nothing for your business in Beijing, nor in dealings with any Chinese entities who are located anywhere other than where the “contacts” are, and of course there are many different levels of such cadres, whom at any time may be in or out of favor. To use an American comparison, it may be great to have friends who are “powerful bureaucrats” in Oregon, or even ones who are in “high places” in federal government in Washington, DC, but what will that really do for your particular business in Alabama, or after there have been changes of administrations?
Also, beware of the person who claims to know everything about an entire industry. China is huge, “young to business (it entered the WTO just ten years ago)” and vastly populated, and is not nearly as easily understood or categorized with accurate national statistics as is the case in the U.S. or in European countries. The likelihood of someone possessing such vast (and accurate, current and complete) information, and who is not otherwise a professor at a major university (or is not running a hugely successful competitor), is very slim, indeed.
Guanxi, like “connections” in the Western sense, can be very useful if it is real and pertinent, but must be handled delicately, and is never a substitute for a long-term strategic plan, with real capital resources in place. Also, the Uniform Foreign Corrupt Practices Act, and equivalent laws and regulations in place in Europe and other jurisdictions, are now being applied in transactions in China, at levels that greatly exceed any applications in the past, and Beijing has also recently increased its scrutiny of internal corruption within China, in several celebrated cases before the World’s media. Clearly, foreign businesses want to stay well clear of any such investigations or accusations, not to mention the liability that could result from findings of actual guilt.
9. Trying to Handle Things from the Other Side of the Planet. As a sort of corollary to the above statements, Western businesses must have trained management on the ground in China, including people who are already quite familiar with the company, its people and its business. This can be very difficult to achieve, as you will need supervisors who are able to speak your native language and Mandarin (and perhaps local dialects, as well), understand Chinese culture and employees (as just one example, Chinese employees often expect to receive an extra month’s salary at Chinese New Year—your business’ failure to state otherwise may cause serious morale, and perhaps even legal, problems with your workforce, and if you do state otherwise, your business may have problems in finding or retaining good employees), work well with Chinese customers and businesses, and also effectively communicate with your business headquarters. Similarly, the people in your business headquarters in the West must also develop clear communications channels with their Chinese operations, and attempt to listen and understand about the situations there, with a focus on the long-term strategic plan, as opposed to short-term “reactive” thinking.
There are now thousands of articles and books available that chronicle how foreign businesses have failed in China, often when those businesses had not been consistently managed or supervised within China, and the “main office” had attempted to micromanage the business in China, from outside of China, and based the Chinese policies and decisions upon foreign business standards and thinking. Doing this right is, of course, something that might require frequent revisions and “tweaking,” which will impose recurrent added expenses (time and energy, as well as money) to the entire venture, which expenses might accidentally have been overlooked in the planning stages.
As one businessman from Wenzhou once told me, “we can start businesses here on very little money, and if they fail, we can just start over and try again—but this is not the case for foreigners over here. It is very hard for them! But foreigners must know that we would have to spend so much money to set up a good multinational business in their countries—to do that would cost us much more than it would cost the foreign people who are over there!” To add yet a further note of caution, “closing down” a failed, foreign-owned business in China can be a very difficult process, and should not be assumed to be simple or cheap. So this is even more of a reason that no foreign business should ever enter into business in China without first having a proper strategic plan in place.
10. Globalization and Looking Beyond China. As China continues to develop as a world power, with double digit annual rates of economic growth, and the cost of doing business there in turn increases, in some circumstances China simply may not provide the “perfect all-in-one global answer” for some foreign businesses today, or may only provide some answers (and such may also only be temporary ones). Just as having a complete strategic plan is an essential starting point before any business should embark into China, the same planning should also examine whether other international locations, outside of China might fulfill some (or all) of your business needs more effectively, now or in the future. Global business in this new decade must be treated as really just that, as opposed to a now-common bridge between super powers in the West and China. Scores of countries other than China (whether they are in Asia, Eastern Europe, Latin America or Africa) have been and are attempting either to “copy” the Chinese business models, or to modify and update their old business and economic models to make them more relevant and generally competitive for current and future international businesses. Certain countries may be able to offer good and effective low-cost solutions for some of your business needs. Depending on your business and industrial sectors and needs, it could be a serious mistake not to evaluate other geographic regions for your business development.
Your advisors must be able not only to help you to assess your strategic goals and needs, but also how, where and when you would be best placed to satisfy those needs strategically, in a proper diversification model, and finally, when you are ready, we will help to prepare the legal documentation and materials that will then bring your business to that very point, as well. We work hard to stay on top of how business is being promoted to grow and develop globally, and we work together with some of the finest international consultants and planners in helping businesses to analyze, plan, structure and implement, and then to evaluate, assess and modify their international structures for the near and distant futures, in order to make them more globally competitive, cost-effective and sustainable.
For more information on this topic, please contact David Woronov.
This Alert is provided for information purposes only, and does not constitute legal advice. According to Mass. SJC Rule 3:07, this material may be considered advertising. ©2011 Posternak Blankstein & Lund LLP. All rights reserved.