Basic advice for overseas companies trading in China
China is the great economic success story of the past 30 years. It’s now the world’s largest economy and a huge and expanding market for international businesses. China is not one single market. Although the laws are in principle effective all over China, you will need to understand the regional economic and legal practices in order to develop the right legal strategy for trading in China.
When drafting contracts in China, it is important to bear in mind that your ultimate goal is to have a precise and enforceable contract. Many companies have been left empty handed because their contracts lacked these characteristics. Specificity of the terms is key. For example, if a certain transistor can usually dissipate nine watts before it overheats, it is better to say that explicitly rather than rely on “in accordance with industry standards”. Chinese courts are much more reluctant to read implied terms into a contract than some Western jurisdictions. Additionally, to maximize your chances of enforcing the terms of a contract in China, the contract must be in Chinese, apply Chinese law, and the forum selection clause must choose a Chinese jurisdiction. Otherwise you risk having a contract which is unenforceable before a Chinese court. The only time a party should use a different forum and law is if the other contracting party has significant assets overseas which cannot be easily transferred.
Many businesses encounter serious legal issues because they did not choose the appropriate structure for their entity or did not fully comply with the associated registration requirements. Companies can choose between a Wholly Foreign Owned Enterprise (WFOE), a Joint Venture (JV), a Representative Office (RO), or a Variable Interest Entity (VIE). Your selection will depend on the nature of your business, and each carries certain risks. A WFOE must be incorporated in accordance not only with national laws, but also local regulations which, among other restrictions, have varying requirements on employment and leases. A JV may give you access to a partner’s business network, but increases your risk of IP theft. A RO is severely circumscribed in its activities, and is only suitable for the most limited ventures. A VIE in many circumstances may actually be illegal under Chinese law because they are frequently used to circumvent Chinese legal restrictions on foreign enterprises.
Using Agents and Manufacturers
Businesses sourcing products from China may engage directly with a manufacturer or a third party agent. It is critical to know with whom you are dealing. In many cases, when procuring a product from a Chinese based entity, it is unclear whether you are contracting with a third party agent or a manufacturer. In the case of breach, it would be much easier to enforce a contract against a manufacturer than a third party agent because the latter rarely keeps substantial assets on hand. Some agents may be particularly beneficial, but identifying them requires substantial investigation into their historical performance and the manufacturers they contract with. It is vital to do the required due diligence on any party you contract with to ensure that it is a registered business entity which is appropriately licensed under Chinese law.
Regulatory Compliance and Enforcement
Every business must adhere to Chinese regulations, which vary from industry to industry. For example, if selling health or cosmetic products in China, there is a host of regulatory requirements that must be complied with, and the dangers of noncompliance could lead to incarceration of the responsible officers. This is more common in China than abroad because it is easier to pierce the corporate veil in matters involving public safety. Additionally, each industry must be aware of the consequences of the anti-corruption statutes in their home jurisdiction and in China. While enforcement may be selective, it is never wise to give the authorities a reason to prosecute your business. Prosecutions against foreign enterprises for regulatory violations will likely increase because of the recent economic slowdown in China.
Ramifications of the Business and Legal Culture
China’s culture is quite different and presents difficult issues for any foreign entity. For example, in the legal arena equity tends to play a much larger role in a judge’s decision than in Europe or common law jurisdictions. Accordingly, where circumstances change and dramatically impact the Chinese entity negatively, its foreign counterpart may want to look at modification before litigation, which in many cases leads to an expensive and negative outcome. The negotiation process is also quite different in China. One difference is that in Western nations it is common to bring attorneys to the forefront early on in negotiations, whereas in China, this may be seen as a move taken in bad faith. A business must be thoroughly aware of Chinese business and legal culture to maximize its potential earnings.