Doing Business with China and Your Reputation Risks

Doing business with China just got another level of riskier.

1. What The CCP Does In China Does NOT Stay in China

Ten years ago, our China lawyers would explain to our clients how what they did in China might redound to their detriment outside China. Three years ago, our China lawyers started explaining to our clients how what the CCP does in China might redound to our client’s detriment outside China. Now, our clients are explaining to us how what the CCP is doing in China might redound to their detriment outside China.

In December, 2019, in Will Your Business in/with China Hurt Your Business Reputation Outside China? we wrote about reputation risks for businesses that sell Made in China products or do business in China. That post began by referring back to an August, 2019 post, The Top 14 China Wild Cards/Future Risks, that listed the top 14 risks for foreign companies doing business with China. In that post we wrote about how there might eventually be a “tipping point” when China’s human rights record starts negatively impacting companies doing business with China:

There may be a tipping point when consumers in the US and the EU and elsewhere become so troubled with how China treats its Uyghur and Tibetan populations (see this and this) or how it is acting against Hong Kong or Taiwan or with its efforts to exert control outside China. These sorts of things are leaking out more of late as the bloom is off the rose and we are hearing more and more from our own clients (American and otherwise) saying that they are having employees refuse to go to China or consumers complaining about their goods being made in China. Take a company like Patagonia which has a stellar reputation for caring about the environment and people and even goes so far as to call itself The Activist Company; how much longer can it maintain its moral high ground while still having some of its products made in China?

2. Few Companies Saw China’s Crackdown on Hong Kong as a Business Issue

Our August 2019 post discussed how our clients did not see much risk stemming from China’s crackdown on Hong Kong, which was in its nascent stages back then, and how they were mostly telling us the following:

1. Americans don’t even know what goes on in the United States, much less in China.

2. China is better than X country and nobody seems to care what X country does.

3. The U.S. generates more ill-will in the world than China.

3. China’s Feud with the NBA got Just a Few Companies Thinking 

But just a few months later — after China bullied the NBA for Daryl Morey of the Houston Rockets having tweeted support for protests in Hong Kong — our clients became more pensive about their worldwide risks arising from doing business with China. See China and the NBA are coming to blows over a pro-Hong Kong tweet. Here’s why.

Though “likely none” was still the most common answer to our questions regarding the impact the NBA-China feud would have on our clients’ businesses, they started sharing comments like the following:

1. I don’t think there will be any problems, but this is certainly something worth us considering.

2. I expect everything will blow over and be fine in a few weeks, but this might have a tiny impact on our sales in the meantime, but I doubt even that.

3. I can see how some people really care about this, but unless it rises to the level of a real movement, I do not see it having any real impact.

4. The Xinjiang Papers and Calls for Boycotting China Worried Some Companies

After the Xinjiang papers and increasing calls to boycott Chinese products and the Beijing 2022 Winter Olympics, and especially after international sports stars like Mesut Özil, Sonny Bill Williams (and more recently, Enes Kanter) started speaking out against China, many of our clients began worrying. But as we wrote in December, 2019, “virtually nobody was planning to cease doing business with China tomorrow over China’s human rights issues, but many now see China’s bad actions as a potential threat to their business outside China.” But around this time, many of our clients’ views on how China’s bad actions might impact their businesses began shifting to the following:

1. If we could stop doing business with China tomorrow, we would. But we can’t. Or if we can, it’s too expensive. Or we can, but it will take a lot of time and now is not the right time to go through that process.

2. We have employees who want us to stop doing business with China and we are taking that seriously.

3. There’s a 50-50 chance this will all blow over within the next few months. There is also 50-50 chance more bad news will come out about China and if it does, the  ______ could hit the fan.

4. Look at our business. I’d be crazy not to be concerned.

5. The CCP’s Handling of Peng Shuai’s Sexual Abuse Allegations AND the World’s Reactions to That Are Worrying Many Companies

The CCP’s treatment of Peng Shuai, coupled with the so many calling for boycotting the Beijing Olympics and products coming from China, and even companies doing business with China, have ramped up client concerns about doing business with China and we are now hearing the following:

1. I’ve been telling so and so at my company that we must move faster to move our manufacturing out of China, but I was the only person truly worried about that. Now, everyone is asking me where we are in that process and what we can be doing to speed it up.

2. If you think it’s bad now, just wait until the Beijing Olympics start. I just wish we could get out of China before then, but that’s impossible.

3. You saw what happened to Jamie Dimon right? That same day, one of our most trusted Chinese employees told us that our company and our foreign employees in China would be better off if all our foreign employees returned home before the end of this year.

4. We need to talk with one of your international trade lawyers to help us figure out what we can do to change the country of origin on our products so we no longer have to label them as made in China. See Avoiding the New Tariffs on China Products: Substantial Transformation is Key and China’s Greater Bay Area and Country of Origin Markings.

5. We sell industrial equipment so I don’t think any of this will impact us directly, but I am worried how this will impact our clients that make consumer products and how that might turn impact us.

6. I’ve had it with China and I don’t know how much longer my family and I can take it here. It’s been six months since I asked to be able to go somewhere else but because nobody in their right mind wants to take my place here in China, I’m still here. And what’s happening with Peng Shuai has only made things even worse for me. My two kids with us in China are begging to go home because they don’t want to be in a country that denigrates and gaslights women.

6. Profit Motives Will Force More Businesses to Confront China

Yesterday, Michael Shuman (who knows the China zeitgeist as well as anyone) wrote a piece for Bloomberg entitled, More Businesses Will Stand Up to China After the Peng Shuai Outcry, positing how profit motives are now causing foreign companies to speak out against China:

The WTA’s [World Tennis Association’s] tough stance has been characterized as a glaring exception. But it could signal a different future for the relationship between China and international business. A confluence of factors—heightened U.S.-China tensions, intensifying repression within China, and, most of all, more pressure on companies outside China to support social equity—will make it harder and harder for big business to turn a blind eye to Beijing’s abuses. The outcome could be a lot more sharp confrontations between prominent businesses and the Chinese state, with the potential to reshape China’s economic relationship with the rest of the world.

This paragraph reinforces what I said two years ago about how there would come a time when companies like Patagonia, will no longer be able to “maintain its moral high ground while still having some of its products made in China.”

Shuman rightly says there is “nothing new about China’s human-rights horrors, nor the awkward position in which they have placed international companies,” but whereas “profits in the gargantuan China market were [for so long] just too juicy to sacrifice”, that is changing, and the WTA shows the shifting business priorities. Per Shuman, the WTA’s unwillingness to back down to the CCP:

[H]ighlights the pressures corporations are facing to play a greater role in ending discrimination and injustice. Every large company now must have an ESG strategy or face the ire of employees and activists. Under a microscope for their efforts to promote diversity, close the gender gap, protect the environment, and support workers, CEOs will find it increasingly uncomfortable to justify their operations in a China where the government suppresses minorities and denies its citizens basic civil liberties.

During the NBA’s kerfuffle with China, a client of ours lost valuable employees because it had begun discussions with a Chinese company about working together in China. After that incident, I told some clients how they should be mindful of how their relationship with China might impact their employee relationships. Some of these clients then told me they had already experienced employee issues arising from their doing business business with China.

7. Doing Business with China is Another Level of Riskier and You Ain’t Seen Nuthin’ Yet

Shuman lays out how Beijing has steadily been making it more difficult for foreign companies to continue doing business with China:

Yahoo! and Microsoft Corp.’s LinkedIn both recently exited the China market amid stiffening state control over information. Meanwhile, Washington’s sanctions related to human-rights issues have also complicated U.S. business in China. The government’s detention of untold numbers of Uyghurs, a Muslim minority in the far west region of Xinjiang, has become a flashpoint. The U.S. barred the import of cotton from Xinjiang over concerns Uyghurs were being forced to work, a step that has caused headaches for apparel brands with supply chains in China. More hurdles are likely. Pending legislation in Congress would expand the cotton ban to all products sourced from Xinjiang.

Shuman is savvy enough to recognize that what makes sense for the WTA, Yahoo! and Microsoft/Linkedin does not make sense for every company that is doing business with China:

None of this means that Starbucks Corp. is about to shutter its Chinese coffee shops or General Motors Co. its car plants. American companies invested almost $300 billion in China from 1990 to 2020, and they aren’t about to walk away. Executives will still try to tiptoe between supporting social causes and reaping riches. Jamie Dimon, chairman and CEO of JPMorganChase, quipped on Nov. 23 that he expected his bank to outlast the Chinese Communist Party, while reaffirming his company’s commitment to doing business in China; a day later, he said in a statement that he regretted the remark.

I disagree with Shuman regarding Dimon’s “tiptoeing.” Dimon never refuted the import or the truth of what he said about the CCP; he merely said he regretted having said it. Dimon is a very savvy CEO and I’m guessing he planned the whole thing to show JPMorgan customers and employees his independence from China and then expressed his regrets to allow the CCP to save just a tiny bit of face.

I do though wholeheartedly agree with Shuman’s concluding paragraph:

The minefield between international companies and China’s bounty will become just that much harder to navigate safely, increasing the likelihoods that there will be more confrontations between Beijing and business, and more executives, like Simon, willing to stand up for social justice against the Chinese regime.

In particular, I agree there will be more confrontations between Beijing and the West. Way back in October 2018, we called the US-China trade war the “New Normal” and in Would the Last Company Manufacturing in China Please Turn Off the Lights, we forecast an inevitable decline in China manufacturing. On May 8, 2019, in The US-China Cold War Starts Now: What You Must do to Prepare, we warned of a “straight line decline in US-China relations” and we laid out what businesses should do to respond to that. Our gloomy predictions have angered many, and I get it because what we are saying is not pleasant, especially for those with companies/livelihoods dependent on China trade. Our task is to call things as we see them, not as we want them to be.

On September 8, 2021, I testified before the U.S. Congress regarding US-China economic relations and the theme of my testimony is that the CCP under Xi Jinping prioritizes CCP remaining in power and its ability to control its citizens over anything economic. The below is an excerpt from my testimony that highlights this.

A. The CCP is Cracking Down on Private Businesses

CCP antipathy towards private business is nothing new; it is as old as communism itself. By way of an example, my law firm has represented many of the big U.S. and Australian movie studios in their China legal matters and several of them have remarked how China “hates foreign movie companies” after learning how difficult it is to make movies that pass China’s censorship requirements. Our response has usually been that China hates all movie companies because movies can speak directly to the people.

China also does its utmost to wall off its Internet from foreign companies. It does this by not giving foreign companies Internet content provider (ICP) licenses, which in turn forces them to pay Chinese companies with ICP licenses to host their websites on Internet servers within China. The CCP does this to control online content. Because Chinese domestic companies fear the CCP, they usually do not put anything on the Internet that the CCP does not want there. And if a Chinese company does put something on the Internet that the CCP does not like, a Chinese government official can threaten that Chinese company or even arrest someone from that Chinese company. Doing this to a company whose leadership is in New York is considerably more complicated. As a result, the Chinese company that allows a New York company to use its ICP license will make sure the New York company does not put anything on the Internet that might offend the CCP.

As another example, the CCP does not allow foreign companies to operate schools that teach Chinese children and it recently banned private tutoring in core school subjects. Again, the CCP worries quite a lot about individuals and companies that have the ability to reach large audiences.

Does China not care about foreign investment? Does China not care about its own economy? My answer to these questions today is the same answer I’ve given 5, 10, and 15 years ago: China cares about both foreign investment and its own economy, but only to the extent that those bolster CCP power and help ensure its survival.

As a lawyer, the best example I see of the tension between investment and economics on the one hand and CCP power and control on the other hand is China’s court system. Our clients often ask me about the fairness of China’s courts and my answer is always the same. If you are suing a Chinese company for breaching your contract to make rubber duckies, you will get a fair trial. If you are suing a Chinese government company for stealing your cutting-edge semiconductor IP, well . . . good luck. Many China lawyers call this the 90-10 rule. Ninety percent of the time the Chinese courts will rule fairly because that allows China’s economy to function and that benefits the CCP. But when a case is important for the CCP, fairness instantly gets tossed out the window as the court will always rule to benefit the CCP. Legal scholars describe this as rule by law, as opposed to rule of law.

The same is true for Chinese IPOs in the United States and for VIEs. China allows select companies to IPO in the US — oftentimes via VIEs – because it wants the money. But if for any reason the balance shifts and  prohibiting an IPO or a VIE, the CCP will – as it has done frequently lately – block them.

Variable interest entities (VIEs) are an excellent example of how the CCP operates. The CCP has allowed VIEs because they bring in foreign capital, but it has never formally legalized them. Now that the CCP is making clear in various ways it no longer values VIEs as much as it once did, investors and underwriters are panicking. But this writing – actually, more accurately, lack of any writing – has been on the walls all along for anyone interested in looking. VIEs have always operated in a legal grey zone; never clearly legal or illegal. This grey zone allows China to permit them while also allowing them at any moment to prohibit them or shut them down.

The same is generally true for China’s new laws and regulations on data privacy, which are geared more towards giving the Chinese government access to data than towards protecting Chinese consumers. The media has recently come out with many articles on China’s “new” data privacy laws, but at their core, the new laws do not differ much at all from those that preceded them. The Chinese government has for years had essentially full access to all data, even data held by foreign companies operating overseas. The new laws mostly just reiterate and clarify this and should be viewed not so much as new laws, but as the CCP signaling that companies that collect data the CCP does not want them to collect or that seek to hide data from the CCP are at risk of government action.

B. Why is the CCP Accelerating its Crackdown on Private Businesses Now?

First off, let me make clear again that the CCP has been cracking down on private businesses and free speech and the rule of law pretty much since Xi Jinping assumed power.

The CCP’s recent crackdowns on private businesses should not be surprising, both because similar crackdowns have been going on for so long and because they were entirely predictable. What I find more surprising is how many people are expressing surprise about the crackdowns. When people tell me they did not see them coming, my response is, “Right, how could you possibly have known there were communists in China?” “And why would you not expect a country that is – at the very minimum – engaging in a cultural genocide against its Uyghur and Tibetan populations to respect private property, private businesses, and the rule of law?”

On July 27, in an article headlined “Wall Street Gets a Chinese Education: The Communist Party Control Always Trumps the Needs of Investors”, the Wall Street Journal’s editorial board had this to say about the CCP’s antipathy towards private business and lack of concern for the economy: “The big surprise from this week’s slump in Chinese company stocks is that people are claiming to be surprised. President Xi Jinping has made plain for years that he intends to bring ever greater swathes of China’s private economy under the state’s control. Guess what, Wall Street: He meant it.”

Western businesspeople have been getting China wrong for a long time, largely because they tend to assume that everyone acts strictly out of economic self-interest. But for the CCP, the economy is a means to an end, with the end being a socialist state fully controlled by the CCP.

Xi Jinping and the CCP are Marxists, and Marxists believe that after capitalism comes socialism and after that comes stateless communism. China has been moving along Marx’s stages of development since Mao, and Xi Jinping appears to believe China is nearing the socialism stage, so it can start throwing away more and more capitalist elements. That is exactly what its crackdown on private businesses is doing. The West’s recent efforts to disengage from China are another reason why the CCP is accelerating this crackdown now.

 Did foreign investors not know these things about China? Many did not. Businesspeople and investors typically are trained to look at industries and companies, not governments.

However, many did know, but for monetary reasons, did not want others to know. When my firm’s lawyers write anything remotely critical of China, expats in China (who profit from China) will often tell us they wish we would not write about such things because our articles might encourage their companies to pull out of China and put them out of their jobs. Few businesspeople have any incentive to tell the truth about China.

What are you seeing/hearing out there? How do you see businesses that are doing business with China being impacted? How will businesses that have their products manufactured in China be impacted?

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