China Business: We Never Said it Would be Easy

Tough times make for tough business and China is certainly no exception. For foreign companies doing business in China or even with China, we are already seeing increasing problems and/or the likelihood of increasing problems in the following four areas:

1. Disappearing Intellectual Property.

Local software company (not one with which you are likely to be familiar). Tells our China IP lawyers it wants to sue its employees in China over IP violations. The conversation went sort of like this:

China IP Lawyer: What are the IP violations?
Software Company: They stole all our software.
China IP Lawyer: What do you mean they stole all of your software? Who stole it.
Software Company: The people we hired to develop specialized __________industry software for us to market in China.
China IP Lawyer: How did this happen?
Software Company: We started the company in China about two years ago. I hired Mr. Wang [name is made up] to lead our operations there and he eventually brought on about 20 more people for us. I knew him from my days with _________ and thought I could trust him. We spent two years on this and more than a quarter of a million dollars and the product is now finally ready and they’ve just taken the whole thing for themselves..
China IP Lawyer: Do you have written contracts with these employees that include non-competes, trade secret protections, or non-disclosures?
Software Company: No. We don’t have written contracts with them because we wanted to keep this really under the radar. Mr. Wang told me that if we didn’t keep everything under the radar that our software IP would get stolen and I trusted him.
China IP Lawyer: Did you pay employer taxes, or any China taxes at all?
Software Company: No. We weren’t exactly their employers.
China IP Lawyer: What do you mean?
Software Company: Mr. Wang was our only employee. We would send him $10,000 a month and he would use that for everything he needed, including to pay the other employees.
China IP Lawyer: Who exactly sent Mr. Wang the money?
Software Company: Our company. Our U.S. company
China IP Lawyer: Do you have a Chinese company?
Software Company: No?
China IP Lawyer: Do you realize that virtually everything you have described to me was illegal in China?
Software Company: I do now.
China IP Lawyer: I do not see how you can sue anyone. Essentially, we would be asking a Chinese court to rule in favor of an American company that, for all intents and purposes, was never in China. Our claim would be that the people who stole your IP were your employees, even though there is no evidence they were your employees and if we argue that they were your employees, we will be admitting you violated nearly every China employment law on the books and you would literally risk prison for tax evasion.Did you ever register any of your IP in China?
Software Company: No,
China IP Lawyer: That might have helped…..
Software Company: Can you help us.
China IP Lawyer:  I don’t want to tell you that we cannot help you without first doing all sorts of research to confirm it, but off the top of my head, I just do not see your having a lawsuit worth bringing in either China or the United States unless these China people start trying to bring your software into the US.
Software Company: It just seems ridiculous we paid these people for so long and China won’t protect me at all.
China IP Lawyer: Right, but from China’s perspective — and most countries would be the same — operating illegally usually precludes you from flipping around and then trying to take advantage of the legal system
Software Company: But it was one of their own people who tricked me.
China IP Lawyer: Right, but the government will say that you should not have relied on him and that you should have been there legally and paying your taxes and you also should have registered your IP in China. It’s possible you hold the copyright in China anyway and we would be happy to research this for you.
Software Company: I’ll get back to you on that.

They never did.

Our China attorneys are seeing more instances of employees (real employees, oftentimes those whose salaries have been cut) seeking to use their employer’s intellectual property. If you want to protect your IP in China, do things legally. This means you, at minimum, register your business, use written contracts (in Chinese) with your employees that include trade secret protections, and you register your IP in China
When times are good, there is a much greater belief that loyalty will lead to long term reward. When times are bad, there is a much greater tendency for people to try to grab onto any potential short term rewards.

2. Disappearing Chinese companies.

We got one this week and they are definitely becoming more common. Here is how they work. Chinese company on the verge of shutting down takes an order from Western company anyway. Chinese company then ships out the dredges of its product before shutting down for good. We have been called by companies that received dirty rags instead of shirts, that received bricks instead of fish (this actually was during the Asian crisis), and that had received what looked like sugar instead of candy. In all of these cases, the Chinese company had taken the money and had simply disappeared.

Chinese law does allow for piercing the corporate veil to go after owners for fraud in these circumstances but few Chinese judges are familiar with this concept and even fewer are enamored with it. I am not saying such a case should never be pursued in China, but I am saying that one must think long and hard about whether pursuing such a case makes economic sense.

Now more than ever, you must make sure you know as much as possible about those with whom you have business dealings. You also should strive not to pay the entire cost in advance of the products you are buying. A year ago, most Chinese manufacturers were requiring full payment in advance. That has changed and many of our the contracts my firm is writing with Chinese manufacturers are now calling for anywhere from 0 to 50% payment upfront. Do your due diligence before you send your money.

Joint Ventures Gone Bad.

We are working on a number of failing joint ventures right now where the Chinese joint venture partner ceased providing financial reports and ceased remitting any profits back to the Western joint venture participant.

Labor Laws Violations.

I just received an email from co-blogger Steve Dickinson regarding China’s labor laws and the belief among many foreign businesspeople that those laws are being relaxed to prop up the economy. Here’s Steve’s email:

I have been seeing statements on blogs and in the press that foreign companies no longer have to worry about Chinese labor law because the falling economy has led the Chinese government to basically abandon the law. This is untrue and it is a dangerous belief. What the government has been doing is working with large employers in negotiating mass layoffs and wage reductions. However, this process is part of the labor contract law, not a rejection of it. Moreover, all the other provisions of Chinese labor law, such as minimum wage, working hours and safety are being even more strongly enforced now than ever, particularly against foreign companies.

I am in the process of reading the numerous policy documents coming out the the current National People’s Congress. One thing that is being constantly stressed at the NPC is that China has no intention of responding to the world economic situation by turning back from the last 5 years of reform. Its intention is the opposite. China’s leaders see the non-Chinese economies as even more unreliable and risky and they are pushing even harder to make China self reliant and thoroughly modern. They do not intend to allow the financial crisis to push back the recent trends of Chinese development. Two of those trends are to shift away from export led growth and to shift away from reliance on foreign direct investment. For exports, they want to move from being a foreign outsourcing center to a country that exports products of its own design. For FDI, they want to shift from quantity of FDI to quality of FDI. Many foreign observers thought (and still think) that China would turn away from these goals in the face of the financial crisis. Exactly the opposite is happening. China is reconfirming these goals in its search for economic stability.

When the Chinese government puts out a notice in English that it is going to strictly enforce a particular law, the only wise thing to do is to believe it.

What are you seeing out there?

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