China, International Law

Doing Business In China: 10 Minutes To Legal Mastery

What should American companies be thinking about if they are looking to go into China and vice versa?

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Many years ago, I spoke at a U.S. China Business Conference where I was tasked with talking about the legal issues American businesses face in China and the legal issues Chinese businesses face in the United States. I was given 10 minutes, after which I would be on a panel.

My initial plan was to condense my one-hour speech into 10 minutes and talk really, really fast, but once I realized that would not work, I decided to take a different tack. I would instead give a forest-not-tree overview of what American companies should be thinking about if they are looking to go into China and vice versa.

The below is basically what I said.

Since U.S. businesses pretty much have to deal with all of the same legal issues in China that they have to deal with here in the United States — and then some — there is not nearly enough time for me to discuss specific Chinese laws.

So instead, I am going to talk about the general approach U.S. companies should take regarding their Chinese legal matters.

There are two keys to not getting burned by China’s legal system. The first is to not assume China’s legal system is anything like ours. The second is to not assume China’s legal system is different from ours.

In other words, the real key is that you must not assume anything.

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I have seen countless instances where American companies have encountered problems in China because they just assumed that China’s legal system is like ours.

A couple years ago, a pretty good-sized U.S. company called me to form their Wholly Foreign Owned Enterprise in China. They talked with great pride of the half-million-dollar study they had just finished which showed the huge demand there would be for the business service they would be starting in China.

They were floored when I told them foreign companies cannot go into their proposed business in China without a Chinese joint venture partner. It had never even occurred to them that what was legal in the United States might be illegal in China.

Joint ventures present a great example of where American companies get into trouble for assuming China’s laws are just like ours. In the United States, owning 51% of a company pretty much means you control the company, and so Americans frequently just assume that if they own 51% of their Chinese joint venture they will control the joint venture.

The problem with this assumption is that it is not based on Chinese law, because in China, control of a joint venture depends mostly on who has the right to appoint the joint venture’s representative and managing directors.

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And let me tell you something, I am convinced there is a school somewhere in China that teaches just about every Chinese business to give their American joint venture partners 51% of the joint venture company and control of the joint venture’s Board of Directors, and then, in return, the Chinese company extracts from the American company the right to be able to appoint the joint venture’s representative and managing directors. The American company goes along with this, not realizing that even though it owns a majority of the joint venture, it has just given up its ability to control it.

Many years ago, I heard a story of an American who was renting an apartment in Shanghai. Now I am not even sure if this story is true or apocryphal, but it is such a good story to illustrate how Chinese judges and arbitrators view contracts it really doesn’t matter whether it happened or not.

It was a nice apartment that this American was renting, and it had a really nice, expensive office chair (high-end apartments in Shanghai are usually rented out fully furnished). One day, the really nice office chair broke and became unusable, and the American tenant kept asking his Chinese landlord to replace it. But that wasn’t happening.

The lease on the apartment eventually came up for renewal and the American refused to renew it unless the landlord put in writing that he would replace the really nice office chair. The landlord agreed, and after the new lease was signed, the landlord came by and put in a $2 metal folding chair.

What would happen in the United States if this tenant were to sue the landlord over the landlord’s failure to replace the office chair with something pretty comparable?

The tenant would win because the court would essentially “write into” the lease contract the provision that the replacement chair had to be a good office chair like the one it was replacing. What would happen if the tenant sued the landlord in a Chinese court?

The landlord would win, because if you want something in your contract in China, you had better put it in there.

Why is this chair story even relevant? It’s relevant because American companies frequently fail to put enough into their contracts with Chinese companies. Instead, they just assume the Chinese courts or arbitrators will know what the parties intended, and re-write their contracts accordingly. But it doesn’t work that way in China.

We had a company come to us after having received a large shipment of laptop bags that weren’t strong enough to hold a laptop. We called the Chinese company to ask about getting a refund, and the Chinese company told us that if our client had wanted a bag strong enough to hold a laptop, it should have paid 50 cents more per bag for one that could actually do that. This company should have specified in its contract that it wanted a bag that could hold x number of kilograms.

But if I had to pick one arena where American companies most often mistakenly assume China’s laws are like ours, it would be in employment. There’s an old expression in the United States that employers can fire non-union employees for good reason, bad reason, or no reason at all. It’s the opposite in China, where there should be the expression that you can’t fire or lay off your employees for just about any reason not expressly set forth in your employee rules and regulations manual.

American companies also get tripped up in China when they assume they have no requirement to pay managers overtime or that they can use independent contractors. Almost all employees in China (be they Chinese or foreign) are entitled to overtime pay, and if someone in China (again, be they Chinese or foreign) is doing work for you and they are not your maid or just coming to your house for a day or two to fix your plumbing, they are your employee — and don’t forget how hard it is going to be for you to fire them.

On the flip side, American companies sometimes make the mistake of assuming everything about China’s legal system is different from ours, and I will talk about this by way of an example.

A U.S. company forms its Wholly Foreign Owned Enterprise (a WFOE) in China and builds a really nice factory there. Then, with a couple weeks to go before its factory is set to begin operations, it learns that China is not going to let them import the key chemical needed for their product. This company had spent nearly a year and nearly a million dollars getting the United States environmental protection agency to approve this particular chemical in its product, and they just assumed that because this chemical had been deemed safe in the United States, it could use it in China without having to prove a thing to anyone there. It had never even occurred to this company that China has its own environmental regulations and its own Environmental Protection Agency, and that China would require this chemical go through China testing and would not just accept U.S. EPA testing standing alone. Does anyone think this U.S. company would have thought it could import a chemical into the United States simply because the chemical was on an approved list in China?

But the biggest mistake American companies make in assuming Chinese law is different from the law here in the United States is when they assume that China will not enforce its laws against them because they are bringing a couple thousand jobs to China or because China is not enforcing those same laws against Chinese domestic companies. Both of these assumptions are wrong. For foreign companies, China is pretty much just like the United States in that NOT following the law is a very dangerous way to operate a business.

What about the legal issues Chinese companies face when coming to the United States? Chinese companies tend to have even less experience than American companies when it comes to dealing with foreign laws and they tend not to realize that they cannot handle their legal issues in the United States the same way they handle those issues in China. So just take everything I have said about American companies in China and double it.

Dan Harris is a founding member of Harris Moure, an international law firm with lawyers in Seattle, Chicago, Beijing, and Qingdao. He is also a co-editor of the China Law Blog. You can reach him by email at firm@harrismoure.com.

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