U.S. Supplemental Admiralty Rule B is an amazing rule. Absolutely amazing, and, in many ways, quite unlike anything else in the US judicial system, and so arcane as to not really fit in it so well any more. Under this rule, if a plaintiff has a maritime claim against another party and that other party is not within the district in which the lawsuit is commenced, the plaintiff may seize the defendant's assets without having to post a bond. To put it more bluntly, one party can seize millions of dollars of another party's assets without notice and without having to post a bond. To put it mildly, this is an incredibly strong mechanism to collect money from a defendant.
The rule was originally instituted mostly to aid vessel suppliers in recovering from non-paying vessel owning companies without a local presence that would allow them to be sued locally.
But there have always been a fair number of judges who have hated this rule due to its lack of procedural or monetary safeguards and those judges typically will not issue the attachment order unless the plaintiff has dotted every single "i" and crossed every single "t".
In 2002, the U.S. Federal Court of Appeals (this is the court that covers New York) held that plaintiffs could seize electronic fund transfers (EFTs) under Federal Supplemental Admiralty Rule B. This ruling created a cottage industry of which my firm was a more than willing participant. Let me explain.
Any time there is a bank to bank dollar transaction, the funds "ping" a bank in New York (I borrowed the word ping from the computer world because I think it fits what actually happens). So if a company in Hong Kong pays a company in Japan $600,000, that $600,000 will almost certainly go through a New York City intermediary bank, at least for a split second in time. Or if a company in Nebraska sends $950,000 to a company in China, the same thing will happen. Likewise, if a company in Russia pays a company in Seattle.
Now here is why it matters.
Since nearly all dollar denominated international transactions pass through New York intermediary banks, the ruling meant that a massive number of payments could be seized as they electronically pinged these New York banks, without need even for the posting of a bond. Something around one third of all federal court cases in the Southern District of New York (New York City) involved plaintiffs seeking Rule B attachments.
And my firm was always in the thick of things as a number of our clients are in the business of supply fuel or spare parts to vessels and a number of our clients are in the fishing and other maritime related industries. Click here for an interesting article written by a Dalian attorney about a China cargo arrest we did with that firm back in 2003.
And we loved the New York seizures most of all because there is nothing better to seize than real money. In just the last year or so, we had the following sucesses:
-- We successfully seized funds in New York City that were going from Japan to Hong Kong to collect on debt owed to a Singapore client.
-- We successfully seized funds in New York City that were going from a Korean company to a Russian company to collect on a debt owed to our Hong Kong client.
-- We successfully seized funds in New York City that were going from a German company to a Chinese company to collect on debt owed to our U.S. client.
And in all of these cases, we not only collected every penny owed, plus interest, we also managed to recover our clients' attorneys fees. If you are a foreign company and your funds have been seized in the United States and you really do owe the money, it just does not make a lot of sense to hire an expensive New York City lawyer to fight it, especially if your creditor's contract states that the prevailing party gets interest and attorneys' fees.
But these Rule B EFT cases in New York have always been controversial and, even more so than the traditional Rule B cases, there are judges who hate them. In New York (or so we have been told by NYC lawyers) there were judges who would sit on this cases in the hopes it would be too late by the time they ruled.
Banks never much liked the Rule either because they were forced to spend large amounts of time and money dealing with the courts' rule B orders. And probably most importantly, there has been a growing feeling that maybe the United States should not be doing things right now that encourage foreign transactions to be conducted in a currency other than the U.S. dollar.
But on October 16, 2009 (mere days after I and our local NYC counsel had just secured a Rule B order from a New York court against a Russian fishing company that owed my client money) the Federal Court of Appeals, in the case of The Shipping Corporation of India v. Jaldhi Overseas went off and reversed its 2002 decision permitting such transfers. The court held that its 2002 decision was wrong in finding EFTs to be attachable property.
In my case that was pending at the time Jaldhi came down, we are still fighting for the money on various grounds on which the Jaldhi case has no applicability. But the days of easy seizures of money appear to be over and what was in many cases the best avenue for collecting debt from a Chinese company has just disappeared.
We had a case against a Chinese company waiting in the wings, but that is now on indefinite hold.
It was a good seven years.
Read more: Rule B Maritime Attachments And China. We Hardly Knew Ya.
I am in a terrific China Law ListServ (yes those things do still exist), graciously run by Professor Donald Clarke of the Chinese Law Prof Blog. There are some seriously smart and knowledgeable people on the ListServe and much of the discussion is more geared toward China law academics than practitioners. I typically skim every email, but really read only around 25 percent.
Over the last few days, there have been a number of emails regarding Julie Harms, an American and a Harvard graduate, who has been petitioning Beijing regarding trespassing charges her (Chinese?) boyfriend is facing. I skimmed the first email or two on this and quickly determined Ms. Harms' situation was of no relevance to my law firm, to our clients, or to this blog.
I was wrong.
Petitioning is a "system" in China where citizens (people?) dissatisfied with their local government officials or legal matters (or really, whatever) seek to voice their grievances with "Beijing." According to Carl Minzer describes it as follows:
"[P]etitioning’ [is] a traditional means of seeking justice firmly rooted in Chinese history. Defined broadly as an effort to “go past basic-level institutions to reach higher-level bodies, express problems and request their resolution,” petitioning includes a variety of practices that parallel, overlap, and in some cases replace formal legal channels. These practices have survived into the post-1949 People’s Republic of China in the form of citizen petitioning of numerous “letters and visits” (xinfang) bureaus distributed throughout all Chinese government organs, including the courts.Development of a modern legal system over the past two decades has not eliminated these petitioning practices and institutions. Formal Chinese legal institutions have developed internal means of accommodating petitioning behavior. Since the 1990s, Chinese authorities have also passed a web of regulations to govern both petitioners’ practices and the operation of national, provincial, and local xinfang bureaus.
Today, I read a really interesting post on the Law & Border Blog, entitled, "Would a Foreigner Complain about Chinese Visa Problems Through the “Petitioning” System?" The Law & Border blog is written by a US lawyer, Gary Chodorow, whose practice focuses "focuses on representing companies and investors in U.S. visa matters." So, Chodorow naturally focuses on whether foreigners might start using China's petitioning system to seek resolution to their China visa issues and his post concludes by seeking "reader comments about whether it may be useful for a foreigner to make complaints about China visa issues through the petitioning system."
Which got me to thinking. Might foreigners also use the petitioning system to complain about other Chinese legal matters as well? What about an employer who unfairly loses a lawsuit to an employee? What about the owner of a Wholly Foreign Owned Entity (WFOE) who is not allowed to leave China because a Chinese citizen is falsely claiming the WFOE owes him or her money? The possibilities are endless.
I know almost nothing about the petitioning system but I think I know enough to know that it is not likely to be a viable option for foreign businesses. Right? What do you think? Ms. Harms' actions certainly do at least raise some new issues.
Read more: China's Petitioning System. A Veritable Appellate Court For Foreigners?
Bill Russo, China car expert extraordinaire, has been running an excellent series of posts on China's car market and he just hit the lucky number 8 and final one and this one really got my attention. It is entitled, "TREND #8: China’s Rapidly Changing Demographics and Growing Demand in Lower Tier Cities," and its focus is on China's demographics relating to car sales in China. But it really is a terrific short briefing on China's demographics as they are relevant to business.
If you are dong business in China or thinking of doing business in China, particularly if you are selling product or services in or into China, I suggest you read it. And it certainly would not hurt you to read the seven posts that preceded it.
This post is a re-hash of a post Steve did more than three years ago. We are re-running it now as part of a series of posts we will be running over the next few weeks on the Basics of China Business Law. We are even forming a new category for this series, the first since we started this blog!
This post focuses on the forming of a Wholly Foreign Owned Entity (WFOE) in China. I am starting with this type of entity because it is the one we do most often. Subsequent posts will detail the steps required to register other forms of entities in China, such as a representative office (RO) or a contractual or equity joint venture (JV). Each of these forms of foreign invested enterprise (FIE) is subject to its own specific laws and to numerous regulations that apply to all FIEs. Every FIE is formed as a Chinese limited liability company (LLC).
Where the special laws and regulations of an FIE do not apply, the provisions of the Chinese Company Law control. The Company Law was recently completely rewritten to conform more closely to international standards for company formation and management.
The steps for forming a WFOE in China typically consist of the following:
1. Determine if the proposed WFOE will conduct a business approved for foreign investment by the Chinese government. For example, until recently, China prohibited private entities from engaging in export trade. All export trade was handled through certain large, state owned trading companies.
China recently abandoned this system, and now both foreign and domestic companies can set up trading companies. Restrictions on export oriented trading companies have essentially been eliminated, but there are still controls on import oriented trading companies that can increase expense and raise costs. Because these rules were only recently changed, the local regulators who must approve these projects do not have a great deal of experience with the attendant issues. This can lead to some delay in the approval process. It also results in an extremely cautious approach towards adequate capitalization even for export oriented trading companies. I discuss capitalization requirements in greater detail below.
2. Determine if the foreign investor is an approved investor. Basically, any legally formed foreign business entity is authorized to invest in a WFOE in China. China especially welcomes investment that promotes the export of Chinese manufactured products. The investor must provide the documentation from its home country proving it is a duly formed and validly existing corporation, along with evidence showing the person from the investor who is authorized to execute documents on behalf of the investor. The investor also must provide documentation demonstrating its capital adequacy in its country of incorporation.
To meet these requirements, the following documents are normally needed from the investing business entity:
a. Articles of Incorporation or equivalent (copy)
b. Business license, both national and local (if any) (copies)
c. Certificate of Status (Original)(U.S. and Canada) or a notarized copy of the Corporate Register for the investor or similar document (original)(Civil Law jurisdictions)
d. Bank Letter attesting to sound banking relationship and account status of the company (original).
e. Description of the investor's business activities, together with added materials such as an annual report, brochures, website, etc.
a-d are translated into Chinese. e is either translated into Chinese or summarized in Chinese.
Many investors created special purpose companies to serve as the investor in China . The Chinese regulators have become accustomed to this process. However, the Chinese regulators will still seek to trace the ownership of the foreign investor back to a viable, operating business enterprise. Investor secrecy is not an option in China. However, the corporate register for the Chinese company will merely state the name of the foreign, special entity investing company as the owner. In that sense, as far as public disclosure is concerned, the investor privacy can be maintained. The foreign investor should also understand that this tracing process will add some time and cost to the Chinese company formation process.
3. Chinese government approval for the project. In China, unlike in most countries with which Western companies tend to be familiar, approval of the project by the relevant government authority is an integral part of the incorporation process. If the project is not approved, no incorporation is permitted. The two are inextricably linked.
The following documents must be prepared for incorporation/project approval:
a. Articles of Association. This document will set out all of the details of management and capitalization of the company. Nothing can be left for future determination; all basic company and project issues must be determined in advance and incorporated in the Articles. This includes directors, local management, local address, special rules on scope of authority of local managers, company address, and registered capital.
b. Feasibility Study. The project will not be approved unless the local authorities are convinced it is feasible. This usually requires a basic first year business plan and budget. We typically use the client produced business plan and budget to draft up the feasibility study (in Chinese) that will satisfy the requirements of the Chinese approval authority.
c. Leases: An agreement for all required leases must be provided. This includes office space lease and warehouse/factory space lease. It is customary in China to pay rent one year in advance and this must be taken into account in planning a budget because the governmental authorities will be expecting this.
d. Proposed personnel salary and benefit budget. If the specific people who will work for the company have not yet been identified, one must specify the positions and proposed salaries/benefit package. Benefits for employees in China typically range from 32% to 42% of the employee base salary, depending on the location of the business. Foreign employers are held to a strict standard in paying these benefit amounts. The required initial investment includes an amount sufficient to pay salaries for a reasonable period of time during the start up phase of the Chinese company.
e. Any other documentation required for the specific business proposed. The more complex the project, the more documentation that will be required.
All of the above documents must be prepared in Chinese.
4. It usually takes two to five months for governmental approval, depending on the location of the project and its size and scope. Large cities like Shanghai tend to be slower than smaller cities. The investor must pay various incorporation fees, which fees vary depending on the location, the amount of registered capital and any special licenses required for the specific project. Typically, these fees equal a little over 1% of the initial capital.
On large and/or complex projects, the approval process often involves extensive negotiations with various regulatory authorities whose approval is required. For example, a large factory may have serious land use or environmental issues. Thus, the time frame for approval of incorporation is never certain. It depends on the type of project and the location. Foreign investors must be prepared for this uncertainty from the outset.
Tomorrow's post will discuss a WFOE's minimum capital requirements.
Yesterday, in a post entitled, "How to Start a Business in China -- WFOE," we discussed the basic requirements for forming a wholly foreign owned entity (WFOE or WOFE) in China. One of the questions we are most frequently asked about how to form a WFOE in China is is how much the Chinese government requires in minimum capital. This post follows up on yesterday's post by addressing the minimum capital requirements issue.
Every company in China must have a stated registered capital. This amount is provided in the Articles of Association of the company and is also noted on the company register. Beginning in 2006, this company register is available to the general public. The registered capital includes all of the components of the initial investment in the company, including its start up cash, contributed property, and transferred intellectual property. Where the registered capital is small, the entire amount must be contributed immediately upon formation of the company. If the amount is large, it may be contributed in installments. There are a number of schedules for the percentage and timing of large amounts of registered capital. It is a crime to state a registered capital amount and then fail to contribute. The purpose of registered capital is to provide some notice to creditors of the capital adequacy of the company. Because of this, Chinese regulators take very seriously the rules regarding registered capital.
Registered capital is an initial investment that is intended to be immediately used in operating the company. It need not just sit in a bank and never be touched. It can be used to pay salaries and rent, to purchase product, or for any other normal start up operating expense. Registered capital may include contributed real and personal property used in operating the business. Many foreign investors think registered capital is some sort of security deposit that they can never utilize. This is not true. On the other hand, some foreign enterprises believe they can simply withdraw their registered capital after the Chinese company begins normal business operations. This also is not true. Once the capital is contributed to the Chinese company, it can never be withdrawn for anything other than paying company expenses.
The only way to get funds from the Chinese company out of China is by repatriating profits or by liquidating the Chinese company. Both of these methods will work, but they both require paying Chinese taxes and meeting other requirements under Chinese law. Investors should also note that the RMB is not a freely convertible currency. For companies that will earn RMB income, the issue of conversion to U.S. dollars or other foreign currency should be carefully considered and a failure to abide by Chinese law all the way along the process will likely lead to an inability to get money out of China at some point down the road.
Under the new Chinese Company Law, the minimum capital requirement for multiple shareholder companies has been reduced to 30,000 RMB (less than $5,000 USD). For single shareholder companies, the amount is 100,000 RMB (around $13,000 USD). However, these numbers have no real meaning for the formation of a WFOE in China.
The real question is what the Chinese authorities will consider as adequate capitalization for the specific project. Of course, that answer varies by type of business and location. For example, it is very expensive to operate a business in Shanghai. On the other hand, it can be very inexpensive to operate the same business in a rural area of China. It is expensive to operate a capital intensive business like manufacturing, but relatively inexpensive to operate a knowledge based consulting business.
The Chinese regulators usually consider all of these issues. To complicate matters, each local regulator has its own basic standards on what constitutes adequate capital for certain types of business activities. These numbers are not published, but when asked they will almost always be provided. They can only be determined through direct contact with the regulator and only after providing a clear explanation of the project. The local regulator virtually never considers the statutory minimum in making a determination regarding adequacy of capital. Rather, the local regulator will determine what it believes is an adequate amount of capital based on all the circumstances. Once the investor has a clear idea of the outlines of a project, it is usually a good idea to engage an attorney to contact the local regulator to see what their response will be to the proposed amount of investment. This initial screening can save a lot of time if the investor's idea of the proper amount of capitalization is dramatically different from that of the local regulator.
In determining what constitutes adequate capital, one needs to consider the peculiar situation in China that building rents are virtually always paid in advance, that payment for products for sale are virtually always paid in advance, and that a reasonable advance reserve for salaries is also required. Thus, the initial start up costs are much higher than in a location like the United States, where credit and time payments are more common. In addition, the foreign investor needs to take into account the risk aversion of the Chinese regulator. The Chinese regulator will not approve a project that looks risky or under-funded. The regulator has no incentive to do this, especially for a 100% foreign owned entity.
The government sometimes permits the minimum capital to be paid in installments over up to two years, though the first installment must be at least 15% of the total amount required and it also must be at least the statutory minimum for total capital. The capital contribution can be made in money, equipment, intellectual property, or other transferable property, but the monetary contribution must be at least 30% of the total capital amount. The government will appraise the value of any non-monetary contribution and our experience has been that it will come in fairly low in its valuation.
We frequently see two big mistakes being made by foreign investors when it comes to their putting in the required minimum capital. Foreign investors hear that assets can be used as a contribution towards the minimum capital requirement, so they go ahead and ship certain assets over to China, with the expectation of then using those assets towards minimum capital. The problem with this approach is that unless the proper authorities have been notified and granted their approval in advance of the shipping, the assets you just shipped to China will not be applied towards minimum capital, and you will have a huge problem on your hands.
The other common mistake we see is the foreign investor putting a value on its assets (including its intellectual property) and assuming the Chinese regulators will put the same value on those assets in determining the contribution towards minimum capital. The Chinese regulators will require their own appraisal (at your expense) l of anything other than monetary contributions towards the minimum capital requirement, and those appraisals tend to come in low, particularly for IP.
Read more: How To Start A Business In China -- The Minimum Capital Requirements For A WFOE
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