Setting Up Your Own Factory in China: The Basics

Despite trade tensions, China’s declining economy, and overall uncertainty, our China lawyers have been getting a steady stream of requests from companies looking to set up their own factories in China. These are mostly companies that supply parts to multinational manufacturers that make products in China and are getting pressure from the multinationals to set up factories in China, presumably out of tariff concerns.

The below email is an amalgamation of internal emails from one of our international manufacturing lawyers to one of our Spain lawyers. It explains the basics of what it takes for a foreign company to set up a factory in China, which is not much different from setting up a factory in Vietnam, Thailand, Colombia, Cambodia, Mexico, or wherever.

We can certainly help with this project. The first thing we typically do is work with the client to determine exactly what they want to do and why. After we get clear on this, we work with them to design a plan that is consistent with Chinese law, on the ground realities, and the client’s own objectives. We have many good contacts in China who are expert in ABC parts who could help as the situation becomes clearer.

Generally, _______ manufacturers want their parts subcontractors to have their own factories in China and using a non-China based factory as the parts supplier will usually not be accepted by the _______ manufacturers in China.

Setting up a factory in China is not an easy process. China has many anti-pollution, safety, local energy supply, and local transport regulations that must be complied with in setting up a new factory, and this is true even if the factory will be located in a well established industrial zone.

The below are what is normally required:

1. Find the best location

The search for a good location should be started as soon as possible. However, it is not possible to find a location until after the general plans for the factory have been completed. The local government/industrial zone operator will require a basic plan for the factory building and a basic business plan before they will consider the feasibility of factory operations in their district. I note that it would be unusual for this type of factory to be located in the _______ area.  Dongbei or Shandong are more likely locations. Most of the _________ factories are in  ______________. These districts are somewhat less concerned about environmental and other feasibility issues.

2. Form a WFOE

Once location has been determined, the foreign company will be required to form a Chinese legal entity, or WFOE. WFOE stands for Wholly Foreign Owned Entity and it is just a 100% foreign owned subsidiary. The application for a WFOE formation involves the following two separate sets of procedures.

a. Formal process for company formation. This is the standard Chinese company formation process. Though this process was recently streamlined, it is still bureaucratic and still requires obtaining a number of documents from the home country. The process is tedious and time consuming, and it should therefore be started as soon as possible. Detailed rules depend entirely on the city and the district in which the company will be formed. But the basic rules are clear enough and we can start work immediately if the client is serious about forming an entity in China.

b. Approval process for operating the local factory. This involves a number of steps/issues including the following:

i. Will the factory building be owned or rented. Both options are possible.

ii. Feasibility study performed by a local professional.

iii. Environmental impact statement drafted by a local professional.

iv. Other environmental and safety reports as required by the project.

Normally, a and b (above) are done contemporaneously so company formation and project approval are completed at the same time. The key issue is determining the factory location. Every jurisdiction in China has a different set of rules so there is no way to know the requirements in detail until after the factory location has been determined.

The PRC just adopted a new Foreign Investment Law that will go into effect in 2020. This means the old rules will be discarded in favor of an entirely new system. This change may happen in the middle of this project, which could cause delay.

The process above normally takes from 6 to 15 months. The fees from our side depend entirely on how much of the process we handle. Some of our clients have us handle just the company formation and the other legal issues that stem from that — leases, employment contracts, vendor contracts, IP registrations, etc. Others have us oversee things like the location analysis, the feasibility/EIS drafting, etc., in which case our fees will be more.

If it is possible for the supplier to use a parts factory outside China, the Chinese entity would be formed as a trading company. This makes for an easier formation process because the feasibility/EIS/safety analysis can be waived. However, noted above, _______ manufacturers in China usually reject this alternative. Moreover, the local governments want jobs, so they also can be difficult to work with when a trading company is proposed. That said, the new Foreign Investment Law is supposed to make this type of trading company approach easier, but who knows whether this will really be the case.

There can be two additional sources of delay. EU companies often resist providing the intrusive company information required by the Chinese government and the advent of the new Foreign Investment Law may make local governments reluctant to proceed, which itself leads to delays. I cannot tell you how many times we have had to explain new laws to local Chinese government officials and convince them that what our client is proposing to do is perfectly legal. That said, _______ parts is a favored industry in China so we expect this project will be welcomed.

Please let us know what the client tells you regarding the above.