Just got this email, which is not too dissimilar from other emails and phone calls I have previously received:
Like I said before, I'm really enjoying your series on China Law Blog on starting a business in China. It's something I might try myself someday.I'd be really interested in hearing about a foreigner starting a local Chinese company through a Chinese spouse. I know this is fairly common (I know of several people who have done it this way), but I'm curious about the details. I hear the registered capital must be of a certain amount, or else it doesn't make sense for the Chinese company to "hire" the foreigner to run the business. And, of course, there are also visa considerations. Then, I guess there's the ugly possibility of what divorce means to the company... but I think that's pretty clear. (If partnerships become possible in the future, will foreign management hires be able to become full partners in this kind of business?)
I'd really love to see a blog post on this angle. Please keep my request anonymous, though... no need to make my employer nervous! :)
Great questions.
Earlier this year, we wrote on what we call the fake China joint venture, which is really nothing more than someone wanting to set up an illegal business arrangement as a way of avoiding the fees and costs involved in forming a real joint venture or Wholly Foreign Owned Entity (WFOE). In that post, we talked about the following as a typical situation:
Caller: I've got this great website and it is exactly what China wants/needs. And I've been working on developing it with some Chinese tech friends of mine and we want to take it legal so we can start getting VC (venture capital) funding for it. Here's our plan. Now I know that the old/truly legal/expected/usual way to do this is for me to form my own company and then form a joint venture with my Chinese partners, but I also know that will cost a lot of money. So our plan is for the Chinese company to own the website and then we will have an oral agreement (or a written agreement) that I really own half of it.
Me: Listen, my firm has been contacted at least twenty times after these situations have gone bad and I am aware of at least another twenty times where the same thing has happened, and let me tell you, these arrangements (it is NOT proper to call these joint ventures) virtually always end the same way. They end with the Chinese company booting you out completely and leaving you with no recourse. Protecting foreign companies in legitimate joint ventures is difficult enough, but it is pretty much impossible under the scenario you are describing. We had a guy who paid us a lot of money once for us to do everything we could to try to get "his" multi-million dollar business back. Guess what, we could not even come close to getting it back. Every Chinese lawyer we talked to about suing to get it back told us we had no chance of winning at all. I mean, just listen to the argument we would need to make to the judge:
Your honor, my client knew that China's laws are very clear on what foreign companies must do to operate legally in China, but he thought these very clear laws should not apply to him because, well because he is an American tech company and he was just too smart/too poor to bother to comply with the very clear laws. So instead, he had this great method for completely circumventing China's very clear laws. His idea was to not form a company, but rather, have his Chinese friends form the company and he would have a little side deal with that company. Well, that side deal has now gone bad and my client wants you to go against China's very clear public policy on how foreign business is to be done in China and enforce this unwritten side deal.
What do you think of that argument?
Caller: (long pause) I understand things could go wrong with that kind of arrangement, but would you be willing to draft the contract between me and the Chinese company?
Me: No. I can't do that. I can't draft a contract that I know will never work. I just can't. Give me a call if you ever want to do this legally, in a way where you actually have a chance of profiting from your work down the road.
We then referred readers to the following:
For more on this, check out "China SMEs, Own If You Want To Own." To get a feel for how difficult it can be even with a fully legal joint venture, check out this article by Steve Dickinson in China Brief, entitled, "Avoiding Mistakes in Chinese Joint Ventures." and this Wall Street Journal article I wrote, entitled, "Joint Venture Jeopardy."
UPDATE: In, "Private Equity, Venture Capital and ‘Fake’ China Joint Ventures," China Hearsay very nicely maps out the way these deals are typically done (using an offshore holding company) and notes that you might have legal recourse in the rare instances where your Chinese partner has "huge assets offshore" in a country in which you can sue and win:
You can tie up the Chinese founders in 100 different contractual knots, but unless those founders have huge assets offshore (real assets, not equity in the holding company) that you can go after in a dispute, they can always tell you to piss off and kick your ass out of the business.
But back to the email and what can happen to a business started through/with a Chinese spouse?
Here are some thoughts:
1. If the marriage works and the business works, then it is all good.
2. If the marriage works and the business fails, the business fails.
3. Because my firm does not represent Chinese nationals seeking to form Chinese domestic businesses (it would not make any sense for them to retain us for this sort of thing), we are not very knowledgeable about this and so I do not know what sort of minimum capital would be required for such a business to hire a foreigner.
4. If the marriage fails and the business works, what happens? This is the key question and I do not know the answer. The business belongs solely to the Chinese spouse, so the question then becomes a Chinese family law issue. What happens under Chinese divorce laws to something that can legally be owned only by the Chinese spouse?
5. What about China's new laws on the "Establishment of Partnerships within China by Foreign Enterprises and Foreign Individuals," set to go into effect on March 1, 2010? These new measures will allow foreign enterprises and individuals to form partnerships with Chinese enterprises and individuals, but it is very hard to say at this point what impact those new laws will have. But, my hunch is that the fees and costs of setting up one of these partnerships legitimately will be roughly the equivalent of setting up a WFOE or a Joint Venture, so I do not see them solving the problem of the foreigner who wants to set up a China business on a shoestring.
The race for best blog in the ABA Journal competition is really heating up and time is running out for me to beg and plead for you to vote for the China Law Blog as best blog in its category. I therefore 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.
Read more: The Fake China Joint Venture, Made Real Through Marriage?
If you like this blog and have not yet joined up as a member of the China Law Blog Group on Linkedin, you are really missing out.
About two weeks ago, I asked the Group to list out what they thought to be the best ten books on China business. Within about a week, Forbes Magazine asked me to write an article on the same thing. That article, entitled, "Best 10 Books On China: Planning your first business trip to China? Here's a guide," just came out today.
So without further ado, here's my list (in the order in which I am suggesting they be read, not in order of quality):
1. Lost on Planet China: The Strange and True Story of One Man's Attempt to Understand the World's Most Mystifying Nation or How He Became Comfortable Eating Live Squid, by J. Maarten Troost.
2. Chinese Lessons: Five Classmates and the Story of the New China, by John Pomfret.
3. River Town: Two Years on the Yangtze (2001, HarperCollins, $14.40), or Oracle Bones: A Journey Between China's Past and Present (2006, HarperCollins, $17.79), both by Peter Hessler.
4.Out of Mao's Shadow: The Struggle for the Soul of a New China, by Phillip P. Pan (2008, Simon & Schuster, $18.48).
5.Postcards from Tomorrow Square: Reports from China, by James Fallows (2009, Vintage Books USA, $10.17).
6. China Shakes The World: A Titan's Rise and Troubled Future and the Challenge for America, by James Kynge (2006, Houghton Mifflin Harcourt, $20.00).
7. The China Price: The True Cost of Chinese Competitive Advantage, by Alexandra Harney (2008, The Penguin Press, $17.78).
8. Mr. China: A Memoir, by Tim Clissold (2005, HarperCollins, $15).
9. One Billion Customers: Lessons from the Front Lines of Doing Business in China, by James McGregor (2005, Free Press, $2).
10. China CEO: Voices of Experience from 20 International Business Leaders, by Juan Antonio Fernandez and Laurie Underwood (2006, John Wiley & Sons, $14.96); and/or Where East Eats West: The Street-Smarts Guide to Business in China, by Sam Goodman (2008, BookSurge Publishing, $18.99).
If you want my explanation of the above, please go here for the Forbes article. And if you disagree (or agree) with me, please let me (and everyone else) know by commenting on this blog post or by adding to the ongoing discussion on our Linkedin Group.
Stanley Lubman, an esteemed Chinese legal scholar, now at UC-Berkeley, wrote an excellent piece this week for the Wall Street Journal's ChinaRealTimeReport. The article, entitled, "Stanley Lubman: Business in China: What Does ‘Playing by the Rules’ Mean?" sets out the dilemma faced by foreign businesses operating in (or with) China: Can they "do business in China without violating the law?"
I recommend you read the whole article, but if you choose not to, at least read the conclusion below:
In an era when the Chinese market is increasingly important to many global businesses, some over-eager participants may be tempted to bend the rules for fear of being “left out” or missing a good opportunity. They should resist the temptation, and heed McGregor (p. 122), who notes that many foreign companies “have policies of zero tolerance for corruption in China, and still do good business because their products are the best and in demand.”
I buy that.
Read more: Playing By The Rules On China Business. Rules, What Rules?
My clients know way more about their businesses than I do. My job as lawyer is to tell them how I perceive the legal risks and rewards of whatever they are doing and then work with them to help them decide how to proceed. I contribute on the legal side, they on the business side.
Every so often, my firm gets a client who has the "perfect" agreement that it has been using forever and they want us to make it work for China. Okay, no problem. Most of the time.
Other times though we face a real battle and that battle really rests on how one defines "perfect." Sometimes our clients consider the perfect contract to be one that just really really protects them. In every single way. Late delivery? Chinese company has to pay a massive amount in liquidated damages? One item out of one hundred not quite up to snuff? Again, the Chinese company has to pay liquidated damages well beyond any possible harm to our client. Payment by our client? Payment by our client? Ten percent now, the rest upon delivery and confirmation of quality. Oh, and the Chinese manufacturer must not make any even similar product for any other company.
All of the above is well and good, but the reality is that the only Chinese companies that sign such agreements are doing so for Wal-Mart or are doing so, knowing full well they will never abide by it. So when confronted by clients who absolutely insist on these "perfect" contracts and refuse to listen to our advise regarding the realities of the Chinese market, we go ahead and write the contract per the clients instructions. We then sit back and wait a few months for them to return to us to write a brand new contract that someone will actually sign. Or sometimes, the client comes back to us and tells us they no longer want to try to do business in China because nobody there is reasonable.
The best contracts are not perfect for any one side; the best contracts are those that provide the most protection possible, while actually working in the real world.
What are you seeing out there?
Shanghaiist just posted my list of "China’s top 5 business law trends of 2010," which list included China stepping up its tax collection efforts. Drastically.
Speaking of drastically, I just read a really excellent article by a swarm of O'Melveny & Myers lawyers, entitled, "China Adopts Controversial Vodafone-style Extraterritorial Tax and Disclosure Rule," discussing China's just circulated Circular 698. The O'Melveny article summarizes an "amazing" part of that circular as follows:
However, Article 5 of Circular 698 then takes an amazing leap. It [Article 5 of Circular 698] states that foreign entities are required to disclose all indirect transfers of PRC resident enterprises to the PRC tax authorities in cases where an intermediate holding company through which such transfers are made are located in a low tax jurisdiction or such jurisdiction exempts income tax on foreign-sourced income. In this case, the foreign enterprise making the indirect transfer must disclose the following documentation to the PRC tax authority in the location of the PRC resident enterprise within 30 days of executing the transfer contract:i. Equity transfer agreement/contract;
ii. Representations regarding the relationship between the foreign entity and holding company being transferred in terms of “capital, operation, sales and purchase etc.”;
iii. Representation regarding the operation, employees, bookkeeping, and assets of the holding company being transferred by the ultimate foreign entity;
iv. Representations regarding the relationship between the holding company being transferred by the ultimate foreign entity and the PRC resident enterprise, in terms of “capital, operation, sales and purchases;”
v. Representations regarding the reasonable business purpose with respect to the transfer of the holding company; and
vi. Other materials requested by the tax authority.
The article then very nicely lays out some truly extreme examples of where foreign companies may be required to report to China on their foreign M&A activity and then asks the following series of questions relating to whether the circular is "even legal:"
(1) Is there a legal basis under any validly promulgated PRC law or administrative regulation which imposes information reporting obligations and tax with respect to such indirect transferors? How does an interpretive circular like 698 derive its PRC legal authority?(2) Does the PRC general anti-abuse rule (“GAAR”) in the EIT grant virtually unlimited power to the PRC tax authorities concerning transactions, including matters of extraterritorial jurisdiction? How does one sentence in a quasi-civil law statute encapsulate an entire doctrine?
(3) Is there a colorable theory under international legal principles to assert extraterritorial jurisdiction over the numerous parties potentially described in Circular 698?
(4) Will the enormous administrative complexities and burdens created by the disclosure mean erratic compliance and result in grossly unfair application of the rule? Can most foreign entities comply?
(5) Will local PRC tax bureaus be staffed with the resources, training, and other administrative infrastructure to deal with those disclosure actually submitted?
This circular is so far out of the norm and so likely to cause an uproar I suspect much of it will never come to pass. No matter what though, it is a great indicator of China's strong desire to increase its taxing powers, especially with respect to foreign companies.
For more on Circular 698, check out the following:
-- Detailed Analysis of of Circular 698, on the China Tax Insights Blog.
-- "China Reinforces Tax Administration of Share Transfers by Non-resident Enterprises," by the Mayer Brown law firm.
-- Tax Alerts by PriceWaterhouse and Deloitte.
UPDATE: China Tax Insight just did a new post on Circular 698, entitled, "One Last Post on Circular 698," taking Deloitte to task for saying "Circular 698 creates some legal questions as to whether the Chinese government has the right to tax foreign companies."
Read more: Circular 698. Or How China's Tax Authorities Are Plotting To Take Over The World.
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