Doing Business in and with the People's Republic of China - Compliance and Legal and Social Audits

 Many companies, big and small, are either doing business with companies (and people) in China or are thinking of doing this. If you don't think you are, just look at the seller on Ebay, As an American attorney who lives in Shenzhen China (near Hong Kong) here is some basic general advice (feel free to contact me for more information):

I.                   Methods of doing business with the Peoples Republic of China:

There are several methods of doing business with the People’s Republic of China. The easiest way is just to purchase goods (manufactured or otherwise) or sell goods, without any activity or presence in China. Historically, this is the reason Hong Kong became an economic powerhouse. Foreign companies dealt only with Hong Kong entities, and left it the their Hong Kong counterparts to deal with China. This has simplicity and minimization of risk as a principal advantage. Of course, hiring a third party company (such as one based in Hong Kong) can help avoid “having a presence” in China.

Nonetheless, as discussed below, depending on the nature of the Buyer’s/Manufacturer's business, and their specific needs and concerns, some of the issues discussed below still apply. For example, in the “Social or Moral Audit” scenario, it doesn’t really matter where title to the goods passed, nor does it matter if the financial side of the transaction is secure (for example COD with inspection), if one’s company becomes the subject of very bad publicity.

Furthermore, it is common for factories in China to copy or overproduce (for their own benefit) the goods for which they are contracted to manufacture for their clients. Similarly, sell a hot product to your purchaser in China, and don't be surprised if a good portion of what they are really selling turns out to be a Chinese manufactured copy of what they agreed to purchase exclusively from you.

One client of mine designed women’s clothing. Her Chinese factory was scheduled to begin production, and she came to China to supervise quality control. Before going to the factory, as was her practice, she used to visit local Chinese boutiques. She was shocked to find her designs being sold in some boutiques under a different label. In fact, this was so common (and China was perceived to be so poor), that many companies haven’t even cared so long as the sales remained in China and under a different label. Of course, the risk for counterfeits, and sub-standard products all being exported to your markets remain. So even a company with no presence in China should have concerns (which can be addressed) with proper auditing. Furthermore, don't underestimate the size and wealth of the Chinese marketplace, nor the technical abilities of their factories. They have the money and expertise to buy and sell whatever can be bought and sold.

Of course, depending on how the transaction is structured, financially and legally, quality control can also be a big issue. An audit can supervise production and reject, on the spot, defective products, avoiding both delays and disputes, and even rejection by customs (in your country) when the goods are imported into your (foreign) country.

The need for proper protection becomes more acute if any intellectual property is involved. That includes trademarks, copyrights, and patents. China does offer protection for such property, but it is not automatic. Nothing should be taken for granted. Registration in China is necessary, and should be done promptly and correctly. It should be noted that China is notorious for taking advantage of foreign companies who fail to protect their intellectual property rights in China, or who delay in doing so.

The other side of the “picture” are companies who desire (or require) a presence, to some extent, in the People’s Republic of China. That may be merely an occasional visit from you or your employee (the foreigner) to discuss a purchase of goods. Or perhaps you will find it profitable to establish a foreign owned and managed company in China (whether a factory or retail sales). Each of these implicates additional needs for legal and other compliance protections. The greater your presence in China, clearly, the more you need (as both a legal and practical matter) to be protected and concerned.

Such issues are discussed below.

II.                Legal Audit:

Doing business in the People’s Republic of China can be quite lucrative, as there is both a highly skilled, low paid, labour market to produce goods, as well as an massive and wealthy market for the purchase of both consumer and other goods. Make no mistake about it, there are a lot of Chinese with a lot of money and they love to spend it on foreign goods. I had a cup of foreign coffee with my son today. The going price is $6 USD for a single cup. Similarly, China needs to import many raw materials and component parts to fuel their export driven economy and domestic needs.

On the other hand, doing business is fraught with hidden and obvious legal challenges, which can become costly, problematic, and even criminal. One is required to not only follow the relevant laws, rules, and regulations, but also to see that they are fairly applied and enforced when applied to you, the foreigner in China.

While things are changing at a rapid pace in China, things are quite anarchistic at the current time Furthermore, it is likely that the next round of legal developments will actually be to enforce existing laws, to the detriment of those who ignore them, especially foreigners, even though there are simultaneous efforts to “liberalize” laws for foreigners.

Accordingly, anyone who is doing business in China is encouraged to have both qualified local counsel as well as non-Chinese internationally skilled legal counsel make sure that:(i) exposure in China is limited to the extent necessary; and, (ii) important local laws are complied with.

When I say “important,” there are two classes of laws which I am referring to. Those that are important to the client in terms of protecting and creating wealth, such as protection of international property (trademark registration, patent protection) and also for example choice of law provisions,, and drafting important contracts which contain, for example, Hong Kong arbitration clauses.

Then there are other “important” laws which need to be complied with because the failure to comply with them can bring negative monetary and even criminal sanctions in China and elsewhere.

The later involves two sub-classes of laws. There are foreign “Domestic Laws” which impose criminal sanctions in one’s own country for what one does in another country (China).

The USA law known as the Foreign Corrupt Practices Act (“FCPA”) provides extra-territorial jurisdiction for the actions of USA citizens in places like China. In the old days, what one did in a foreign country was between that person and the foreign country. After Americans became victims of terrorism, the USA and other countries began to take the view that they had legal jurisdiction over conduct which occurred outside the USA by non-USA citizens and also by USA citizens. That quickly spread to “sexual tourism” and the FCPA, as examples. Other countries have similar laws (the UK has the UK Bribery Act for example). As we all know, there is now a tremendous focus on tax evasion, tax avoidance, and money laundering which is occurring outside the “domestic” country. Where this will lead, no one knows.

Second, countries like China have a multitude of laws, rules, regulations, and procedures,  and they are getting very serious about them. Everything from immigration and visa control laws, to currency regulations, to the enforcement of the proper and required procedures for foreigners doing business in China. Of course, many of the laws implicate the legitimate concerns of the Chinese government in, for example, collecting the proper taxes and revenue. But China also seeks to exert control, to a great extent, upon what goes on in its borders, for other reasons, such as political stability and economic protectionism. This extends not only to “formal” requirements such as registration of foreign companies, but even requiring foreigners who visit China (who do not physically reside in a registered hotel) to register with the local police department within 24 hours. Of course, China takes a great interest, and imposes penalties, upon violation of such things as its labor laws, competition laws, etc.

III.             Laws of the People’s Republic of China:

The Wall Street Journal reported in January of this year that “…doing business in China is getting tougher.” They cite “…unclear laws, perceived antiforeign sentiment, overcapacity…”

Nonetheless, in my opinion, the Chinese government seems determined to keep the “doors opened,” especially in aspects of international business which are likely to increase their GDP and/or currency reserves (suspected to be dangerously low). There are also issues (in China) relating to the strength of the banking sector, bad loans, and a bubble in the housing market and stock market, all of which keep up the pressure on the Chinese government to encourage foreign trade and investment. Furthermore, the presence of a huge wealthy massive domestic market can not be ignored.

Areas of importance:

Taking money out of China: While it is possible, and legal up to certain limits, there are strict currency controls and procedures, and make no mistake, the government is cracking down on this. Furthermore, it is often done secretly and illegally by, for example, a local Chinese vendor, supplier, or partner, who, for example, may wish to be paid in Hong Kong or another country, or who may request an adjustment to an invoice. This is something which could cause an unwitting foreigner to face severe civil and criminal penalties.

Another new law of importance affects, at least on paper: National Security. This law, which is still being drafted and implemented, requires, for example, companies with data on computer servers, to have that information physically located in China. Sometimes, the rule is nonsense, when actually applied, and appears irrelevant at best and outright protectionist at worst.

It is important to note that many of the Chinese laws, rules and regulations have multiple reasons. Some represent legitimate government concerns. Others represent protectionism in its purist form. Others represent a desire for “social control” which is designed to protect the absolute authority of the Communist Party of China, and efforts to guard against perceived threats thereto.

 Furthermore, the laws can be complex. There are a multitude of “Free Trade Zones,” “autonomous economic zones,” etc. Each has different laws, procedures, and rules, etc. Each are run by officials with varying incentives, sophistication, etc. In Shenzhen, where I live, a company located a few blocks away, in the newly created Qianhai economic zone, will have different (and more liberal) laws, rues, and procedures.

Even more compelling, directors and senior managers of foreign non-Chinese companies (unlike the practice in many western countries) may face civil, administrative, and/or criminal liability if their company acts in breach of Chinese law, administrative regulations, or even a company’s Articles of Associations. That liability can apply to foreigners who never set foot in China (although extradition becomes an issue.) Foreigners who have such problems while in China can be prohibited from leaving China while these issues are outstanding. This can take years and tremendous legal fees. Good Chinese lawyers are as expensive as lawyers in the west.

What are some more specific regulations, as examples? China is a member of the International Labor Organization (ILO) which prohibits the employment of minors under the age of 16. Yet this remains a big problem in China. There are many other laws which regulate the employment of labor, including minimum wage, benefits, and workplace safety (along the lines of the OSHA regulations of the USA). All of these need to be complied with, and should be complied with. The list is complex and varies from region to region, and is constantly changing.

IV.             Quality Control, Compliance with Purchase Orders, Customs Regulations:

The old saying “an ounce of prevention is worth a pound of cure,” could not be more true in China. Even if the transaction is structured to the advantage of the non-Chinese foreign country, countless problems can arise by “ignoring” what is going on in China. No one wants litigation in any country, no matter how fair and reasonable. Even if you can sue in your home country, in your native language, and under the laws of your own country, good luck in collecting if you have not thought ahead (with proper legal planning). Furthermore, late deliveries, inadequate quality, etc. can cause your customer or purchaser (like you) to lose your customers, incur expenses, etc. Quality Control, on the spot at the factory, is especially helpful for many companies.

Additional problems arise when importing goods into a foreign country from China. While the foreign purchaser may be satisfied with the goods, or unaware of their defects, technical problems, intellectual property issues, and consumer safety issues can have the goods stopped at various Customs. In some countries, this can be a matter or mere inadequate labeling.

V.                Moral and Marketing Reasons for Audits:

We have touched briefly on the legal issues and consequences, both within China and abroad, for companies who fail to know and follow the laws of the Peoples Republic of China. This was one reason for the existence of Hong Kong as an economic powerhouse. Historically, China lacked the legal and financial institutions to even handle significant commercial transactions. It was easier to avoid China altogether, even more so to avoid the anarchistic and hodge-podge of laws, rules and regulations, and corrupt, lax, and irregular enforcement. So most companies paid a little extra to deal with Hong Kong “middlemen,” and were able to avail themselves (in Hong Kong) to a relatively honest, modern and fair banking and legal system. The need for this is diminishing, however, as are the benefits. They simply “washed” their hands of China. This is no longer a viable or even advantageous option.

For example, many prestigious companies in the United States have come under severe criticism for the working conditions at the factories which actually manufacture the goods they sell. In my personal opinion, this criticism is well deserved. It has become irrelevant as to the number of “middlemen” involved, and equally irrelevant as to the lack of knowledge of management as to how their goods are produced. There is a constant, and in my opinion, well deserved and needed, requirement of social responsibility for purchasers and manufacturers to ensure that workers are, at a minimum, treated according to the laws in which they live and with a minimum standard of living (timely payment of wages, safety, etc.) Furthermore, while the bad publicity can be detrimental, the good publicity can also be an effective marketing tool. Studies show that consumers are more likely to purchase, even at a higher price, goods which were made with environmental and humane factors considered. No one wants to purchase a shirt for a few pennies less if that shirt was made with slave labor.

These social audits are becoming more the norm, and more required, if not by law, by business practices. But they have to be conducted diligently, by people who know what they are doing. Mere cursory inspections are inadequate. Walmart, for example, did an inspection at a “certified factory” in Guangdong, approving a production of several million US Dollars on Christmas specialty items. Unknown to the inspectors, none of the items they inspected had actually been manufactured at the factory they inspected, but instead had been inspected by a rogue factory which did not meet the inspection standards. Hazardous work conditions, like locked fire escapes, persist despite audits by the biggest USA companies. The focus on factory monitoring has increased since the Rana Plaza factory collapse in Bangladesh killed more than 1,000 workers.

V.             Business Reasons for Audits:

Many of the reasons for an audit should be clear. First, it is best to comply with the laws to take advantage of their protections and privileges, as opposed to running afoul of these laws, and risking the severe consequences.

Second, the moral and marketing reasons are equally obvious. No one wants to be associated with a fire or calamity that kills innocent workers working in sweatshops. It is bad for business. On the other hand, the efforts a company makes to supply socially responsible goods can be an effective marketing tool in a price competitive market. Many companies actually require some degree of certification.

But the last issue, which has not been touched on, is that to some extent, depending on the violation, the efforts of a company are relevant, whether to a finding of liability (moral or legal). Hiring a responsible auditing company not only provides additional assurance of compliance with the law, but it also supplies some defense if there is a problem. Again, the nature and extent that this defense can apply depends on the violation, but it can never hurt to have at least made a real and significant effort at compliance.

Feel free to contact the author at GinsbergLLC@aol.com.

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