Quasi-Legal In China: Not the Place you Want to Be

Our China lawyers have gone through many China downturns in the last twenty years, but none to match the current one.

China’s relations with the rest of the world are in a free-fall and China’s economy is hurting. Whenever either of these things are true, China steps up its tax collection and compliance enforcement against foreign companies and individuals and it is doing both of these things right now as well. On steroids, actually.

Now is not the time to be operating quasi-legally in China.

I wrote emails yesterday to two foreigners (both Europeans) living in China and looking to start digital businesses there, and both my emails were essentially the same:

Without knowing a lot more, I have to say that what you are proposing to do is incredibly risky, especially now. If you are committed to staying in China while you try to get a new business there off the ground, the safest thing for you to do would be to make it seem like you are in the EU and do everything “outside” China under an assumed name and never do anything live in China. With China monitoring pretty much everything though, even that is very risky as China will likely discover that you are tied to the person with the assumed name and then come after you. So I counsel against this. too.

If you want to be safe, you move out of China before you do any of this or you just don’t do it.

I have been getting many emails lately from which I get the sense the people contacting me are already doing what they tell me they are contemplating doing and seeking some sort of assurance they are not putting their freedom in danger. They seem to want confirmation that they have somehow found a loophole nobody else has found and getting the blessings of an attorney will somehow make what they are doing legal.

But I have no magic oil to sprinkle on illegal China businesses to make them legal.

Those who think they are operating “sorta” legally in China are similar to those who think they are “sorta” protecting themselves by doing a “sorta” joint venture with their girlfriend. One of our lawyers sent me the following email regarding a company that wanted to operate mostly legally in China but with an illegal contract:

If they are going to operate illegally in China, they should go 100% illegal. That is, enforcement either through really strong family connections (your father knows her father) or enforcement through gangsters and the like. I know people who have succeeded this way but I don’t know anyone who has succeeded with an illegal contract. This is not because contracts don’t work in China, because our lawyers have won enough China contract cases to know that they do.

It is because Chinese judges are on to these sorts of arrangements and they know they violate or seek to evade Chinese law. They therefore have and will continue to deem such contracts void. Why do people live in this fantasy world thinking they somehow are so different or that they have discovered the solution? Why do they think a Chinese court would enforce a contract designed to evade the law?

Take an alternative example. Remember __________’s company we formed in Beijing a few years ago? Not sure if you remember this, but that investment was with his Chinese wife. However, we did that as a very formally organized WFOE and left the wife and her family with the irregular side of the deal. His US company is the only shareholder and he runs the board. His company has had no trouble and he has had no trouble because he is legal and secure. His U.S. LLC — and with it, the China WFOE — were just purchased by _______ [a publicly traded Fortune 200 company]. The reason the purchase was successful is that the whole company was “clean” and therefore it could be purchased by a public company.

As lawyers, we are never going to tell a client to go full illegal, but as a blogger, I have to admit that going fully illegal usually makes better sense than paying a lawyer to draft a void contract or to set up an entity that will be operating beyond its legal scope. To put it more bluntly operating partially legally and partially illegally does not protect you against your illegal actions, it only makes those illegal actions easier for the Chinese government to spot. Operating part-legally and part-illegally puts you at greater risk of being caught than if you were to just go full illegal. I think most people know this, but their rightful discomfort at operating completely illegally makes them want to clutch on to something that will allow them to justify (however falsely) their actions.

Get fully legal now or get out of China.

What does it mean to be fully legal? At minimum, it means the following:

1. Your company is doing nothing more in China than it is legally allowed to do.

2. If you are in China, your company (or companies) outside China are not doing anything with China that China does not want foreign companies to be doing with China. This is an important one because it is so often missed. If your foreign operations are going to operate in a way China deems illegal, you should not have people from any part of your company in China because they are the ones who will be at risk.

3. Both you and your company are paying all required taxes.

4. Both you and your company are current with all vendors and employees, including with all required employee benefits and overtime payments and vacations.

5. Your company is current with all its required registrations.

6. Perhaps most importantly, it means you immediately remedy any clever shortcut you may have done to get around any Chinese law requirement.

Now is not the time to cut legal corners in China, It just isn’t.

And if you do not know exactly what it is required for you to get fully legal in China, you should have someone who does know this audit your China business to flesh out the changes you need to make.