Doing Business in China: Distinguish Business

Issues from Legal Issues

by May Hao

 

January 12, 2003

In the past few weeks, I have received numerous inquiries from business people (or their business consultants) who are in the process of setting up some sort of business in China.  Some businesses are in the form of outsourcing, some are setting up joint ventures or wholly foreign owned enterprises, while others are acquiring an existing foreign interest or state owned interest in a Chinese entity through a merger or acquisition transaction. These companies all seem to have made significant progress with respect to their China projects, but met with some unexpected issues.

 

I studied the issues, most of which were legal. I noted that the reason the companies were unable to effectively resolve the issues is that they treated legal issues as business issues and did not get appropriate legal advise at an early stage.

 

Let me illustrate my point by examples.

 

Two businessmen, unknown to each other, told me similar stories: when they tried to outsource their business (one for manufacturing and the other for IT), they spent a lot of time on locating business partners and geographic locations, and handling other business issues related to their projects in China. The process was long, but smooth.  Now, they each were ready to sign the contract with their Chinese partner.  To their surprise, however, they and their Chinese partner could not reach agreement on certain “technical issues," such as the methods for dispute resolution (should it be litigation or arbitration? and if arbitration, should it be done in or outside China); the governing law for their contract (should the contract be governed by Chinese law or the laws of a state in the United States); the amount of the penalty for breaching the contract, etc.  Their projects, not surprisingly, were put on hold during the impasse.  I told them that these issues were not just “technical issues”: each point had significant legal ramifications and was always the focus of joint venture negotiations.

 

A medium-sized US company was about to sign a supply contract with a Chinese state owned company. The US company had been looking for a “small factory” in China to produce modules at low cost.  When it came time to sign the contract, the US company became concerned that the factory may not have the ability to meaningfully assume the liabilities arising under the contract. The US company wanted the parent of the Chinese business -- a large state owned company -- to be a party to the contract.  The Chinese parent did not agree; it argued that its subsidiary was an independent legal entity that had the legal capacity to enjoy its rights and assume its liabilities under law; in addition, the subsidiary was the party to perform the contract.  Unable to resolve the issue, the US company asked whether it should restructure the deal.  Since this was a legal, rather than a business issue, it could have been resolved legally by requesting the parent company give a performance guaranty.

 

Another medium-sized American company plans to set up a wholly foreign owned company in China. They have a long term plan to expand their business in China; therefore, they would want to make sure their wholly-owned company in China has “trading authority”.  They were advised that a sure way to have trading authority is to move their subsidiary into a “bonded area” in China. They wanted me to confirm authority.  I told them that the question depended on whether they wanted their Chinese subsidiary to have trading authority for its own products or for the products of other companies. A foreign investment company located in a bonded area may serve as an export agent for other companies only if such companies are located in the same bonded area. Currently, a foreign company may set up a joint venture trading company with a Chinese party if they meet certain legal requirements.

 

There are many other different inquiries I cannot illustrate due to limited space. The point is that in order to do business in China effectively, a company needs to get legal help for legal issues at an appropriate stage. That can save a lot of time and money.