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It is our nature to explore and seek new opportunities. Just
look at our history with the colonial settlers and the western
pioneers. Such exploration is due in part to necessity, part
to curiosity, part to search for adventure and in many
instances by the hope that the unknown would present bigger
and better opportunities.
We accept the premise that if we are not
moving forward in our lives and in our businesses, we are
declining. Trying to maintain the status quo is accepted as
the formula of failure. Business has explored the
opportunities in Europe, partnered with Canada and Mexico via
the North American Free Trade Act (NAFTA), and expanded its
reach to Central America with the Central America Free Trade
Act (CAFTA). Business has made Hong Kong and Singapore
thriving commercial centers. There is an ever expanding
relationship with India. However, we continued to seek new
opportunity. The allure of a marketplace in the People’s
Republic of China with more than 1.3 billion people commands
attention. We all find ourselves thinking “If everyone in
China buys a T-shirt, we’re rich”!
This article summarizes the information
presented at the Lawyers Associated Worldwide (LAW) Annual
General Meeting (AGM) held in Beijing, China from October
25-28, 2006. The meeting was attended by 94 delegates from 76
different law firms representing 45 countries. The theme of
the AGM was “Doing Business in China” and the event was hosted
by the Beijing member firm, RayYin and Partners, PRC Lawyers
and partners, Hao Wang and Yi Zhou. Currently, LAW has Chinese
member firms in Beijing, Shenzhen, Guangzhou and Hong Kong,
and plans to expand to at least four other cities by the
beginning of 2007. As the primary delegate of the Knox Law
Firm, I had the privilege to attend this meeting and share the
insights from that meeting in this article. Hopefully, the
information will help you pursue real opportunities and avoid
mistakes and misadventures.
Getting Started.
Plan ahead. Despite many flights from the West Coast and
international flights originating as close as Cleveland (e.g.,
Cleveland – Toronto – Beijing), the trip is expensive. Tickets
for business class range from $3100 to over $8000. Planning
ahead will give you the most options at the best prices. For a
survey of the fares and flight options, which with connections
and layovers will range from 22-26 hours for east to west
flights and 14 hours over the Pole, visit a web based travel
service (e.g. Expedia). However, for booking this type of
flight, definitely use the services of your travel agent. Not
only will your agent likely meet or beat the web based fares,
but your agent will be available to assist you in the event
there are problems and you are half a world away. This
assistance can be immeasurable when you are overseas and faced
with language barriers and problems communicating with the
carrier. Cindy at Miller Travel not only saved me money on the
fare, but was the only reliable source of information when the
flight home was delayed for 32 hours.
Passport & Visa.
Another reason to plan ahead is to make sure that your
passport and visa are in order. Generally, the passport must
have at least 6 months remaining before its expiration in
order to obtain a visa. Tourist visas may be obtained with
relative ease, but you should anticipate that you may need a
letter of invitation from a Chinese business that has invited
you to China if you are traveling on business. You typically
will have to send your passport to a visa procurement service
and you should allow at least one week on an expedited basis
and perhaps one month if not expedited.
Do Some Homework.
This is your chance to be a positive role model for your
children (and employees). Before committing yourself and your
resources to doing business in China, prepare yourself with as
much knowledge and information as possible. Read: One
Billion Customers, by James McGregor. Speak to members
of your trade association or local chamber of commerce. Visit
the American Chamber of Commerce People’s Republic of China
website at http://www.amcham-china.org.cn/ mcham/home/index.php
and U.S. Embassy website at http://shanghai.usconsulate.gov
and review the “Resources” “About the USA” and “Trade and
Business” pages of that site.
In the 1980’s, China’s economy began to shift from a “planned”
economy to a “market” economy. This move has spurred
tremendous economic growth in China. The October 30, 2006
China Daily reported that China’s foreign exchange reserves
will reach the $1 Trillion USD mark by the end of November
2006. This figure represents foreign trade surplus and the
inflow of foreign direct investment. Lots of people and
businesses have already asked the T-shirt question. The growth
of the foreign trade surplus is evidence of the speed of
changes taking place in China and the speed with which new
products and competitors are able to adapt and enter the
market. Every bit of information that you can obtain is
information that you will use.
The Chinese Reality.
Andrew Frank, the Managing Director of Oxford Professional
Training, with offices in Beijing and Shanghai, states very
bluntly: “The Chinese reality is different from the US
reality.” China is different. Of course, Texas, California and
Mexico are also different from northwestern Pennsylvania. Do
not try to make one system out to be right and another wrong.
Instead, recognize that the systems are different and
understand how the differences will impact any opportunity
that you may be pursuing. Those considering projects in China
face some issues that are similar to those encountered in the
US. For example, various permits are required, but whereas in
the US such permits may be an administrative burden, the
process to obtain the permit and operate in accordance with
the permit is usually straightforward and a matter of
satisfying the requirements. However, anecdotal evidence
suggests that there are more opportunities for uneven
administration in China. One LAW member recounted that at a
point in time when international pressure regarding
environmental standards was particularly high, a client was
told that in order to resolve the environmental problems, his
facility would be shut down on the following Monday unless it
had an independent supply of natural gas (instead of coal
sourced energy).
Felicia Choy, Vice-President and Co-Founder of Choy-Valentine,
Inc., an international consulting company, advises that those
seeking to do business in China must balance the scale and
complexity against the opportunity and probability of success
of the Chinese venture. Two key factors that are included in
this equation are: understanding the Chinese culture and
understanding the challenges that such an opportunity will
encounter.
The culture and business relationships as well as the factors
that motivate and influence the decisions of your Chinese
partners are different from the culture and relationships to
which you have become accustomed in northwestern Pennsylvania.
To begin to get a sense of the Chinese culture, one must have
an appreciation for certain Chinese characteristics. Some of
these characteristics include:
1. “High context” culture - The Chinese culture is not
as direct as the American/European culture. The Chinese will
rarely say “no” but instead will ask for another proposal,
suggest that pricing is too high, or advise that the proposal
is under review but never directly respond to a status
inquiry.
2. Relationship oriented - Relationships are very
important and all of the cultural characteristics that are
identified relate to establishing and cultivating
relationships.
3. Hierarchy. - This structure is very important. The
Chinese look to a top down chain of command and expect that
the leader will make decisions and that those of lesser rank
will defer to the leader. Be careful not to undermine a
relationship by sending an officer who does not have
sufficient authority to make decisions.
4. Respect for age - “To have an old person in your home
is to have a treasure.” This may be a corollary to the
hierarchy characteristic, but should be considered as you
assemble your team.
5. Food – This is part of the tradition and relationship
building process. Expect breakfast, lunch, coffee and dinner
meetings.
6. Family - Those outside the family must earn the trust
of the Chinese. Again, this is part of the relationship
building process.
7. Time - The Chinese have a long term outlook. It is
not uncommon for western enterprises to advertise the length
of time that they have been in China. This all relates to the
respect, trust and relationship factors.
8. Space - Although there are 1.3 billion people in
China, the concept of space or personal privacy is in the
mind. There is not much personal space in the crowded
metropolitan areas. A Chinese person can be “alone” at a
crowded Beijing intersection because the mind blocks out the
outsiders. This takes some getting used to as you are prodded,
poked and pushed in lines at the airport, markets, buses and
subways.
9. Saving Face - It is important not to put your Chinese
counterpart in an embarrassing position and if you can help
your Chinese counterpart save face or prevent embarrassment,
you will have gone a long way toward earning trust and
establishing a good relationship.
In light of these characteristics, you must be ready to deal
with certain challenges, which include:
1. Earning the trust of the Chinese - Note that this
requires application of many of the factors above including
the hierarchal management style and team building with the
Chinese staff and overseas management.
2. Managing the differences between Chinese legal
structure and the U.S. structure - The different types of
entities for conducting business are described in more detail
below. China has many contradictions. China is a communist
country, but everyone knows the meaning of “How much”? and
“Best price”? Certain industry segments have been protected by
the government and although this is changing, in large part
because of China’s admission to the World Trade Organization,
make sure that your enterprise is authorized to conduct its
particular activity in China. Bribes and kickbacks are often
suggested as the norm. Adopt a zero tolerance policy and stick
to this policy. There may be some loss of customers and some
business disadvantage but the consistent application of the
policy will prevent violation of the Foreign Corrupt Practices
Act and allow your Chinese managers to “save face” with the
consistent application of the policy.
3. Infrastructure and logistics - Notwithstanding all of
the construction going on along the coastline, there are great
disparities in the roads, rail and air service in China.
Inland areas are only now being developed.
4. Skilled labor and management talent – Despite the
fact that there will be 25 million young people entering the
job market in 2006 and 4.5 million graduates entering the job
market in 2006, there will be a shortfall of 75,000 skilled
management positions in China this year. Consequently, you
must be prepared to spend significant time and resources
working with your Chinese team.
5. Retention of quality personnel - This is very
difficult. Those with skill and ability have many new
opportunities opening for them and it is not uncommon for the
local manager, who has developed client/customer relationships
and has been involved with hiring the employees, to decide
that he should have an ownership stake and if none is
forthcoming to open a competing enterprise. China is very male
oriented. You notice the subtle hierarchical ordering in many
areas, and this is just part of the culture that has to be
understood. Anecdotal evidence suggests that the size of the
employer influences worker employment decisions. An engineer
at a small firm reported that although pay, benefits and
future prospects were at least equal to those offered by
Motorola, Chinese engineers would switch jobs to work for the
larger employer.
Choice of Entity.
Those considering doing business in China have several
different options available. A first approach is direct
procurement from a Chinese Facility. See the discussion below
regarding intellectual property so that you do not give away
the farm. Consider using the contract manufacturer for one
component of your product. If this contract manufacturing
works well, then consider expanding the scope of your Chinese
activity.
When you are ready to establish a presence in China, you may
choose among several different legal structures. The first is
a representative office. This is a cost effective and easy to
establish entity. There are no capital contribution
requirements. However, the entity cannot engage in revenue
generating activities. A representative office is often used
as an initial step to determine whether a more committed
undertaking would be profitable. A representative office is
also sometimes used to oversee the activities of a licensee or
to act as a liaison with Chinese clients.
Historically, joint ventures were the legal structure of
choice. This developed because of the prohibition restricting
foreign ownership. The joint venture may be established on an
equity basis (with all parties to the venture making a
contribution of cash or property and having an equity interest
in the joint venture) or the venture may be created on a
cooperative basis (with each party contributing their
respective capital, services or otherwise performing in
accordance with the venture agreement). Joint ventures are not
allowed in every industry. For example, joint ventures are
prohibited in certain education, publishing and financial
service activities. Remember that your local partner is 6,000
miles away. The distance, the language, the customs and other
factors make controlling your partner very difficult.
Investigate your local partner very thoroughly.
Wholly owned foreign entities are now permitted. They are
becoming increasingly common in both the service sector
(consulting and management services) as well as manufacturing.
These generally require registered capital investment of a
minimum $140,000 USD. Depending on the scope of the business,
the minimum capital requirement is one more reason that the
joint venture structure has been and continues to be popular.
Contracts.
The Chinese version of the contract is the official version of
the contract for resolution of disputes in China. Because of
enforcement issues, it is wise to have agreements reviewed and
translated for both you and counsel to review. Also, because
enforcement of claims by foreigners is questionable and
subject to lots of local flavor, it is recommended that
foreign parties dealing with Chinese include a provision in
their contracts that the contract will be enforced outside of
China (e.g., Hong Kong) with the parties agreeing that they
will each be subject to the jurisdiction and venue of the
court outside of China. In addition, it is common practice to
have the contract interpreted in accordance with the laws of
such other jurisdiction. As Chinese legal practices and courts
mature and resolution of contract disputes follow market based
resolutions and precedent, the need for application of laws
from other jurisdictions and enforcement outside of China may
diminish, but at the present time this should be your
practice.
Intellectual Property.
Mother Was Right. An ounce of prevention is worth a pound of
cure.
Despite the government pronouncements that the integrity of
intellectual property rights is essential to China’s economic
growth, patent, copyright and trademark infringement is
rampant in China. For example, Mark Cohen from the U.S. Patent
& Trademark branch office in Beijing, China estimates that 20%
of consumer products are counterfeit and 90% of motion
pictures and software products are pirated or imitated. The
counterfeiting is not limited to consumer or commercial
products but extends to currency. Visitors are warned to pay
the exact purchase price at markets to avoid receiving
counterfeit currency as change. Another common warning given
to tourists is to be wary of the post-sale claim by the vendor
who “returns” your currency as being counterfeit. Likely the
“returned” currency, which you as an honest patron replace, is
fake.
Since foreign investment into China has been and will continue
to grow, there is little incentive for China to make serious
enforcement efforts. The real victims are the Chinese people.
Foreign investors treat the infringement as a cost of doing
business in China, as evidenced by the fact that only 5-6% of
the infringement complaints are filed by foreign entities. If
and when there will be a benefit to China, then, and likely
only then, will the enforcement efforts intensify.
Patent registration and its corresponding protection are
territorial in nature. A U.S. patent will not protect the
intellectual property right in China. Only a Chinese patent
will afford that protection. China is a “first-to-file
country. This means that the first party to register receives
the protection of the patent. This is distinguished from the
U.S. system, which is a “first-to-effect” system that awards
the patent and protection based on when the intellectual
property was put into effect. Chinese design patents are not
subject to examination and are relatively inexpensive to file
(approximately USD $400). Consequently, Chinese design patents
are common and are used offensively and abusively. Mr. Cohen
uses the example of a new style or design for a product
subject to a U.S. patent (but not a Chinese patent) being
exhibited at a U.S. tradeshow. During the show someone takes a
digital photo of the newly designed product and emails the
image to China where it is downloaded and filed as part of a
design patent application. Since this is not examined the “new
or redesigned” product is now registered in China to the party
who submitted the email photo, not the inventor, who will have
to deal with the parties who pirated the concept.
Any trademark that will be commercialized in China must be
registered in China before introduction of the product in
China for any chance of protection. The mark should be
registered with both the Chinese symbols and the letters or
characters of the foreign language and registered under as
many classifications as imaginable to help block abusive
filings by those intent on infringing. Although the
confirmation of your registration may be delayed for several
years because of the volume of filings, without a registration
you will have no opportunity to seek relief.
The following web site offers a Chinese trademark database for
you to review your own registration and the filings by others
who may be infringing:
http://www.chinatrademarkdatabase.com.
There are many enforcement challenges. The Chinese Patent and
Trademark Office is overwhelmed and understaffed. There are
many rules and the best relief may be as part of a trade group
or group of competitors who have similar complaints. If you
have made proper and timely filings and if you encounter
delays or other enforcement difficulties, the aggregate
claimant body stands a better chance to get some attention
than one intellectual property holder whose work has been
infringed.
So, with that discouraging background, what do you do? First,
use local (Chinese) legal counsel to make sure that the
various filings in China are properly made and made timely.
Discuss the requirements with China legal counsel before any
products or designs are exhibited in any way in China. Second,
be practical. There are enforcement problems. There are
limitations in the damages that may be recovered. For example,
copyright infringement civil litigation awards are capped at
500,000 RMB (approximately $62,500 USD). Copyright awards are
not based on a per piece or per use violation, but recovery is
made on an aggregated basis, and there are no punitive
damages, so flagrant violations will not result in
correspondingly high damages. The Chinese courts apply a
fairness principle to reach a result and this will afford a
great deal of discretion to limit an award to a foreigner.
Your best protection is to leave the Coca Cola ® recipe at
home. Third, adopt and practice reasonable business policies
and protocols within your domestic U.S. and foreign operations
to protect your intellectual property. Fourth, review your
employment relationships with key employees. China law will
not enforce post employment restrictive covenants, including
the prohibition on divulging trade secrets, unless there is
reasonable compensation paid during the post separation
period. The compensation paid after separation must be
separate (in addition to) the compensation paid during the
period of employment. A reference in the employment agreement
that the compensation paid during the term of employment is
“adequate” consideration for the post employment protection of
trade secrets and intellectual property will not satisfy the
separate compensation required by Chinese law.
Anecdotes and Lessons.
There is a story about the U.S. business that makes contact
with a potential Chinese partner. There are many meetings and
meals (to establish a relationship and build trust) and they
define the terms of the transaction. Finally, after lots of
meetings and discussions (and the corresponding amount of food
and Chinese spirits), a deal is reached. The Chinese will
purchase parts from the U.S. supplier but in order to obtain
approval, some tips (kickback) must be advanced by the U.S.
supplier. With a deal in hand and some spirits in the belly,
the U.S. supplier pays several thousand dollars to the new
partners and then returns to the U.S. After a few weeks, no
orders have arrived from the Chinese partner and efforts to
communicate fail. The U.S. supplier has been stung. Practice
your zero tolerance policy regarding kickbacks from the very
beginning and investigate your potential partners thoroughly.
It is easy to forget that China is a communist country. After
all, “how much” and “best price” are generally free market
questions. However, there are rules with which we are not
familiar but the Chinese citizens know very well. For example,
taking photographs of the Chinese soldiers is prohibited. Do
not get caught up in any political debate. Many questions that
you may want to ask about Tiananmen Square and the Communist
party should be reserved for your independent research at
home. Do not jeopardize your partners by asking sensitive
questions in public places.
The Chinese culture is very deliberate and the Chinese people
are very patient. As the anecdote above suggests, the
negotiation process is a long and physically and mentally
challenging and tiring process. You must know the range at
which your transaction will be profitable and you must know
when to say “no.” Too many people are too eager just to do
business with the Chinese and either get stung, as in the
example above, or they make a bad deal. Know your stopping
point. This will be difficult after a few glasses of wine, but
it is far better to annoy your partner than lose your shirt.
If the deal will not be mutually beneficial, look elsewhere.
Planning and Next Steps.
If you are still mulling the sale of T-shirts to more than a
billion people, then consider the following game plan. Before
committing yourself and your resources to doing business in
China, understand that investments in China are for the long
term. Do not expect a “quick buck.” You must be prepared to be
committed with a hands-on presence. So, before you buy and
print lots of T-shirts, consider taking a trip to China as a
tourist or with a trade group. Meet the people, eat the food,
and get jostled with the crowds. Make sure that you can deal
with the cultural differences. As a worst case, if you cannot
deal with these differences, you have had an interesting trip.
If you believe your business venture has merit in a foreign
region, but just not in China, do not rule out other parts of
the world with which you can do business. Although China is
getting a lot of attention because of its rapid and tremendous
economic growth, Eastern Europe offers relatively stable
“western style” government, skilled and available workers and
a reasonably good infrastructure. Do not run to China just
because it is the current front page news. If you can deal
with the differences, then you can pursue opportunities and
contacts through your trade association, chamber of commerce
or embassy. You should do some due diligence on your Chinese
partners, either through the American-Chinese Chamber of
Commerce or through local counsel or agents in China.
David M. Mosier, Esq. is a partner in the Erie, Pennsylvania
law firm of Knox McLaughlin Gornall & Sennett, P.C. Mr.
Mosier’s practice includes mergers and acquisitions, general
business and tax matters. With more and more frequency clients
are presented with opportunities outside of Pennsylvania and
outside of the country. Many of these opportunities require a
local presence that an LAW member can provide. The access to
local counsel on the other side of the globe with an email or
telephone call provides clients with not only legal insight,
but also with practical and cultural insight. The LAW Annual
General Meeting in Beijing provided the LAW members with an
overview of the best practices to pursue business
opportunities in another part of this ever shrinking world.
For additional information, please contact:
David M. Mosier, Esq.
Knox, McLaughlin, Gornall & Sennett, P.C.
120 West Tenth Street
Erie, Pennsylvania 16501-1461
Telephone (814) 459-2800; Fax (814) 453-4530
E-mail:
dmosier@kmgslaw.com
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