How To Survive an Increasingly Difficult China

Since October 6, 2018, one of our recurring themes has been that China has become far more difficult for foreign companies. It is what we have been calling the New Normal. This New Normal extends to all foreign companies that do business in or with China, but it has hit U.S. and Canadian companies particularly hard. The New Normal has greatly increased the risks for foreign companies that do business in or with China.

Yesterday, in U.S. Senate Bill to Block American Companies From Storing Data in China: It’s About Time, we wrote about a newly proposed U.S Senate bill that will make it illegal (as in jail time) for American companies to store their data in China. Our post  predicted this new bill would pass and yesterday’s unanimous censure of/warning to China about its human rights violations in Hong Kong ought indicates its odds of passing are overwhelming. At the end of that post we advised American companies to act accordingly and promised we would follow up by explaining what acting accordingly would look like. This is the beginning of that follow-up.

There are essentially three keys for dealing with the new China risks:

  1. Recognize these new China risks exist. Putting your head in the sand and denying that doing business in or with China has not changed is the most dangerous risk of all.
  2. Determine your own China risks. The risks of a Canadian company with 300 employees in China selling cutting edge healthcare products to mostly Chinese government owned hospitals is going to be a lot higher than the risks for a Spanish company that has three quality control people in China to aid it in making leather handbags. It is important you know your own risks.
  3. Confront your China risks. Knowing your risks is only half of the equation. The other half is dealing with them.

Pretty much all of our clients that saw and confronted their China risks early on are thriving, while those who went into denial are mostly panicking. One of our clients that immediately chose to switch its outsourced manufacturing to Thailand is doing great, while another of our clients that makes the same product but somewhat inexplicably chose “to stick it out in China” is talking about closing its business because of plunging sales. One of our clients that makes electronics products decided at the very beginning of the US-China trade war to move out of China “no matter what” now has a thriving low/no tariff diversified supply chain, while most of its competitors are just now scrambling to get out, while still stuck paying rising tariffs and duties. See Getting out — Tariffs push some US manufacturers to exit China. But on the flip side, many of our electronics product clients have virtually no choice but to keep production in China.

What are the China risks foreign companies are facing with China today? The list is almost endless, and it only makes sense to divide those risks between those who are doing business in China and those who are “merely” doing business with China.

This post will focus on what your company should do to reduce its risks of doing business in China if it truly must continue to do business in China. A subsequent post will focus on how many companies (but not all) can switch from a business model of doing business in China to doing business with China from outside China, with little or no negative impact on your business.

You already know that China has laws. You also already know that China enforces its laws. Lastly, you know that China enforces its laws unevenly. China often will enact a law and then not enforce it for a few years and then all of a sudden start enforcing it. China also will sometimes enforce a law for a while and then stop or relax its enforcement of that law. Some regions of China will enforce a particular law, while other regions do not. Some regions will have a law they enforce while other regions do not even have that law. Most importantly for foreign companies, China enforces many of its laws depending on who is violating them. China has always been way tougher in enforcing its business related laws against foreign companies, and nowadays it is way tougher on enforcing its laws against companies and individuals from the United States and Canada and lately (mostly because of Hong Kong) as against companies and individuals from the United Kingdom.

If you are a foreign company doing business in China, the risk you need to know and confront now is that China is working around the clock to find and go after foreign companies that are violating its laws. More than anything, it wants to find foreign companies that are violating its laws in a way that is costing China money.  It wants to find those violators so that it can fine them and thereby profit from them. We can debate as to why this is happening (rising nationalism coupled with a declining economy spring immediately to mind), but those who debate the fact that this is happening will just be wasting their own precious time. I tell clients China is at “ten out of ten” in terms of going after foreign companies right now, but with United States, Canada and United Kingdom (and perhaps South Korea, Taiwan and Norway), it has taken it up to eleven.

There is a lot you can do — even as a foreign company in China — to reduce your risks and the following is our general list of those things. This list is based largely on what we have seen happen in China during high tension/high risk times and we trot it out again now because past performance is a great indicator of present performance. If you are doing business in China you should do the following:

  1. Make sure your WFOE or your Joint Venture or your Representative Office actually exists and is still licensed to do the business it is doing in China. Make sure it is current on its capital obligations. See Doing Business in China Without a WFOE: Will the Defendant Please Rise.
  2. Make sure your WFOE or your Joint Venture or your Representative Office is actually properly licensed to do business in every city in which it is doing business. It is shocking how often this is not the case.
  3. Make sure your company is doing everything correctly with its employees. Consider an employer audit and note that our China employment lawyers have never done an employer audit without finding multiple problems. In other words, the odds are overwhelming that your employment systems are putting you at risk not just for problems with the Chinese government but also problems with your employees, which can so often lead to them creating Chinese government problems for your company. Doing things “how things are typically done in China” is no longer good enough; you must do things in full compliance with applicable laws.
  4. Make sure your company is current on any and all China taxes it might owe. If you think it may not be, it almost certainly is not, and you need a good accountant and fast. Doing things “how things are typically done in China” is no longer good enough; you must do things in full compliance with applicable laws.
  5. Review your lease agreement and the relevant zoning rules. Are you renting from a real landlord? Is it really legal for your business to do what it is doing where it is doing it?
  6. Have a trusted China contract lawyer review your contracts related to your China operations to make sure each and every one of them is legal. Doing things “how things are typically done in China” is no longer good enough; you must do things in full compliance with applicable laws.
  7. Conduct due diligence on your suppliers/manufacturers, distributors, retailers, and e-commerce platforms. Your risk correlates to the company you keep.
  8. China has many business crimes that are not crimes in the West. Know these. See Criminal Law And Business In China: Too Often the Twain do Meet
  9. Make sure your IP has been properly registered.
  10. Make sure your company is not violating a China company’s IP rights.
  11. If your WFOE or your Rep Office or your Joint Venture shares are American or Canadian owned, consider forming a new company (“Newco”) in a country with good relations with China and selling the WFOE Joint Venture share or Rep Office package to that Newco. This rarely makes sense, but when it does, it really does. This is a big decision that can have major repercussions, so do not just run off and do this.

Above all else, be wary, be careful, and be ready for things to just keep getting more difficult.

More to come tomorrow.