Doing Business in China: Opportunity or Misadventure? 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.
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