BizChina

Just got this comment (comment # 63 on our post, "China: First Let's Clear Out The Long Time Foreigners", which poses some pretty important questions and also leaves hanging some very common misperceptions regarding doing business in China:

So here's my question albeit already bounced around but no solid answer given....

JV or WFOE for a new foreign company launching in China?

I am about to launch my company that I have been planning for 8 years and will do things by the book, no qualms about that, but I don't want to start the thing in a realm of probable employee threats, and local competitor company lordship privileges.

Especially if it's capable of being taken away from me over 5 mao (50 cents) missing in a tax audit because someone has decided that my company will look better in the hands of my local competition.

I have seen many situations of law bending to suit local businesspeople to their advantage, and in those situations the victims of such law bending have almost always had little power to protect themselves.

Would not JV be the better option over WFOE?

At least with a local person in a directors chair it would be harder for sharks to pull the company down.

The whole idea of building a company here in China is fearful and daunting but it's what I want to do.

Re: Operating illegal biz in China;

I care not that the govt. closes them down. It would be exactly the same in my homeland.

Should that happen, they only have themselves to blame.

Lawbreaking is lawbreaking in any language.

Yet I do agree, Chinese law is ambiguous by nature and isn't self explanatory where it should be.

I swear, I was asked nearly the exact same question not all that long ago when I was lecturing on the legal basics of foreign investment into China. And just as I did then, I am going to break down this series of questions and statements and answer it. Here goes.

1. "JV or WFOE for a new foreign company launching in China?" Sorry. Impossible to answer. There are just too many variables that go into this determination and you have really only discussed one, and it is one I do not even see as being terribly relevant. In making this decision, the first question that must be asked is whether the business you are planning is legal as either a WFOE (Wholly Foreign Owned Entity) or a JV (Joint Venture). Most types of businesses these days can be operated by foreign businesses in China as either a WFOE or a JV, but there are still some businesses that are completely off limits to foreigners and there are still some businesses that must be operated as a joint venture and not as a WFOE. There is also sometimes the possibility of operating your business as a Representative Office, but those are fairly rare and the scope of those businesses will always be very limited. I also should note that China will soon also be allowing foreign companies to enter China as part of a partnership.

Assuming you can enter China as either a WFOE or a JV, the hard analysis must now begin. Speaking very generally, WFOEs give you greater control than a Joint Venture. Joint Ventures give you the advantage of having a local partner to help you negotiate new territory and also someone with whom you can share the work and the expenses.

2. "At least with a local person in a directors chair it would be harder for sharks to pull the company down." You can put a local person in your WFOE directors chair if you wish. You seem to believe that a WFOE is more likely to be pulled down by sharks than a Joint Venture, but my experience is that the shark most likely to pull down your business is the one you have invited into your swimming pool. All I can tell you is that my firm has never worked on a matter involving a WFOE that got "pulled down" when it was operating legally. I am not saying this cannot happen, but I have never heard of anything like the example you give of a WFOE being shut down for failing to pay 5 mao in taxes. My firm has handled a number of instances for WFOEs that have gotten in trouble with the Chinese government for things like pollution, zoning issues, tax issues, employment issues, etc., and there have definitely been times where our clients have had to pay fines and there were times we did not think those fines were particularly fair. But I am not aware of any client of my firm or any legitimately WFOE anywhere in China being shut down for a minor infraction. I am aware of China changes its rules and making what was once legal for foreigners no longer legal for foreigners with terrible business ramifications, but that is a different issue.

On the flip side, I estimate maybe around ten percent (or maybe even more) of my firm's revenues from its China practice each year comes from our representing foreign companies in a joint venture gone bad. We are typically working on anywhere from one to three of these failed joint venture deals at any given time and they are seldom pretty. If you are a foreign company and you have entered into a joint venture in a third tier Chinese city and your joint venture agreement was badly written in terms of protecting you, you will be lucky to get past the shark in your tank without losing at least half your fingers and toes.

My experience (and I think virtually every China lawyer will agree with me on this) is that you are at much greater risk of being eaten in a joint venture than if you do a WFOE.

3. "Yet I do agree, Chinese law is ambiguous by nature and isn't self explanatory where it should be." This is just not true when it comes to China business law. I have said this countless times and I will say it again. Much of the belief that China's business laws are ambiguous stems not from the laws themselves, but from their varying (and almost universally poor) translations and from people who claim they know what the laws say without ever having read them. China's business laws with respect to foreign investment are, for the most part, very well written and very clear. A couple years ago, we did a post entitled, "China Company Formation Law Is Clear -- WFOEs Are Easy," where we argued that the laws on how to form a WFOE in China have stayed the same for quite some time and really are very clear.

My best advice to you is that you figure out what will be best for your situation, taking into account China's laws and its realities on the ground.

On a pretty much unrelated note, the race for best blog in the ABA Journal competition is really heating up and China Law Blog is hanging on right now with a razor thin lead. That being the case, I strongly urge all of our readers to click here and register on the site and then click here and vote for China Law Blog in the "geo" category. Your vote really does count and it will be much appreciated. Thanks.

In June of this year, China enacted a new Food Safety Law. It is stating the obvious to say that China's food safety is of relevance to the entire world and China food safety is the rare case where both foreign and domestic interests are united in wanting to solve a major problem within the Chinese system.

China's new food safety law takes the position that the food safety problem arises from inadequate central control and from a lack of clear standards and procedures. However, even if this were true, the measures adopted in the Law will not resolve these issues.

The Law created a Beijing based coordinating council called the National Food Safety Commission to coordinate five national level ministries that have day-to-day control over different phases of the food production process. Since the Law does not set out the structure or authority of the new Commission there is no reason to expect this approach will improve central control of the food safety problem. It does little more than create another layer of bureaucracy.

The new Law mandates additional rule-making to regulate every phase of the food production process, a complete review and assessment of current food safety issues, national standards for food quality and safety, and a unified national program for addressing food safety emergencies.

But the Law provides absolutely no details about any element of this program. There are no standards, no time-line, no budget, no procedure for obtaining the input of regulated parties and no procedure for resolution of disputes. It is not uncommon in China for laws to be adopted on controversial topics that leave nearly all of the details to later regulation. The usual result in China is that such regulations never appear, rendering the law essentially meaningless. That has so far been the fate of the standards and procedures portion of the Food Safety Law.

However, even if these difficult issues were to be resolved, the Law will not resolve the food safety problem in China.

Food safety cannot be enforced through government supervision and administrative sanction. Food safety standards function only where there is an effective system of private civil litigation that allows injured parties to take action independent of the government. As with most countries, China simply does not have the funding or expertise to hire qualified inspectors and regulators to enforce to the food safety system. China has over 200,000,000 farmers and over 500,000 food production companies. Its food production system is too vast to allow for meaningful inspection at all stages of the food production process.

The government can play an important role in setting the proper standard, but only when Chinese citizens can use China's court system to obtain damages will China's food safety likely markedly improve. China's tort law system is undeveloped and regulators strongly discourage its use in safety and health related matters.

The Food Safety Law is also not directed at the real problem. In a fundamental sense, China did not need a completely new set of standards and procedures. The previous standards would have been perfectly adequate had they only been enforced.

Chinese farmers and herders are poor and uneducated. Most operate at a loss and only survive by supplementing their income through nonagricultural activities. The same is true of most food processors, who sell into a partially price controlled market and who are frequently on the verge of bankruptcy. These people and businesses do not believe they have the luxury of being concerned with standards and rules and procedures. They make decisions based on day-to-day survival. They will, therefore, take many actions in violation of the law if they believe doing so will give them some financial benefit. They do not worry about the long term impacts. They are only concerned with survival today. In this situation, which is prevalent all over China, no amount of regulation and supervision will have any impact. They ignored the old and simple rules and we can expect the new rules will receive equal treatment.

Having said all this, there is one thing that does seem to be working with respect to China's food safety, at least on the high end and at least in the bigger cities. China's consumers are concerned about the safety of their food and they are hyper vigilant on this score. The food companies know this and they have stepped up their quality control monitoring and they are not shy about getting this word out.

What are you seeing out there?

China's Labor Contract Law (which law applies to every employment relationship in China) is very clear: employers must pay their employees for overtime.

Though there are some exceptions, these exceptions are not nearly as broad or as easy to obtain as is widely believed.

Overtime payments are 150 percent for each overtime hour worked on a normal work day, 200 percent for each overtime hour worked on a day off, and 300 percent for each overtime hour worked on a statutory holiday. China considers forty hours per week as generally considered standard.

Though high level management and other staff can be considered exempt from overtime pay, to be so, prior government approval is typically required. To make matters even more complicated, local regulations definitely can vary on what constitutes an exempt employee and what is required by way of approval.

My firm has handled around a half a dozen cases where foreign companies came to us after having been sued for having failed to pay overtime. In every single instance, our advice and eventual action was to settle the claims because they were all valid. Interestingly, despite all of them having been valid, we were able to settle them for considerably less than full value because the employees were so desirous of getting a lump sum payment and fast.

I thought of these cases today after a reader sent me a China Daily article entitled, "Labor Disputes Skyrocket in Beijing." The article talks about how "about 80,000 [Beijing] workers had been involved in disputes with their employers by the end of November, double the number of last year" and up from 26,000 disputes in 2007. The article then noted how "about 50 percent of the cases were related to overtime rates and payment" and the reader asked me if I had been seeing the same thing elsewhere in China with respect to foreign employers.

My answer was, "Yes." Employees and ex-employees are suing their foreign employers in China way more now than just a few years ago and most of those lawsuits are stemming from a failure to pay overtime, a failure to pay sufficient wages without a written contract, or from a termination not provided for in the employee manual. We are finding these cases very easy to settle at a fairly reasonable cost, but virtually all of these could have been avoided with just basic care. There is no excuse for not paying overtime or not securing an exemption for your employees to whom you believe overtime is not necessary. There is also no excuse for not having a written contract with your employees or a written employment manual setting out the grounds for firing.

Oh, and if you think the person you are paying is an independent contractor and not an employee, there is about a 99.9% chance you are wrong and that person is, in fact, an employee.

What are you seeing out there?