China is Cracking Down on Illegal Land Use: Do You Really Feel Lucky, Foreign Punk?

The following is an amalgamation of a number of conversations I have had over the years with people wanting to register a WFOE (Wholly Foreign Owned Entity) in China fast:

Potential Client: Can you help me register a WFOE in China.

Me:
Yes. Not a problem. Do you have a lease yet? Do you know that a legitimate lease is required for the approval of a WFOE?

Potential Client:
I know that but we are in a real hurry here.

Me:
 Okay. But do you have a lease.

Potential Client:
We have a lease but I don’t think it technically will qualify.

Me:
What do you mean?

Potential Client:
The land is zoned agricultural but my Chinese partner has secured all the okays to allow us to use it for our factory.

Me:
Not a good idea. Trust me on that. We will definitely want to look at the documents giving you all these okays, as I am guessing there is nothing in writing on this.

Potential Client:
The factory has been there for two years without a problem and my Chinese partner assures me that the local government is fine with it.

Me:
The local government may be okay with it right now, but what if the current mayor is pushed out next week on corruption grounds? Do you really want to be in a situation where you have spent a large amount of money on a space that gets shut down? Also, maybe the local government is okay with it right now because the existing tenant is paying them good money under the table to be okay with it. Do you want to be engaging in bribery that violates the laws of two countries (China and the United States) to keep this up?

Potential Client:
I am in a hurry and this is the only space that works.

Me:
Are you sure? You are in a hurry, but is it really going to be worth the few months if you get shut down? And anyway, are you really saying this is the only space that works in all of China, or are you saying this is the only space you have found that can work quickly?

Potential Client:
I am not going to get shut down. My Chinese partner is incredibly connected.

Me:
Incredibly connected to the current local administration, MAYBE, but as I said, that administration could be out the door next week. Beijing checks on these things too and if they see that your facility is illegal, Beijing could see to its shut-down, even if the local government does not want that. Not only that, let’s just suppose that two years from now your connected partner decides he no longer wants to do business with you and asks the local government to shut everything down until you are gone? Trust me, our China lawyers have seen that maneuver many times. I just don’t think it a good idea to go into a WFOE illegally and my firm cannot be a part of that.

Potential Client:
That’s ridiculous. This is how business is done in China. Are you really saying you won’t take us as a client?

Me:
Yes. We won’t take you as a client because we do not want our reputation damaged when you get shut down and we won’t take you as a client because we do not want to be blamed when you get shut down. Most importantly, we do not want to work on something we know will eventually fail, probably sooner rather than later.

Potential Client:
Well I am sure I will have no trouble finding someone to help me on this. Good-by.

I know that at least one of these companies did end up getting shut down (within about a year) because someone at the company who had sided with me on the company not going forward emailed me to tell me of this.

I thought of the above today after reading Cracking Down On Illegal Land Use: The BYD Case. This post is on BYD, “the fast-growing compact automaker in which American investor Warren Buffett has a 10% stake.” Seems BYD has seven factories on land zoned for agriculture and China’s Ministry of Land and Resources is going to be ruling by September 30 on what to do about that:

China Bystander nails it in describing these situations:

It is not unknown for local officials to turn a blind eye to such zoning violations in the drive for economic growth. Companies want to bring new production capacity on stream without waiting for all the red tape to be dealt with, while officials themselves are judged on their promotion of local economic growth and local governments have become hooked on land sales for their revenue.

The ministry has said that 7,800 hectares of land had been used illegally in the first half of this year, a 14% increase over the same period last year. That reversed the trend of the figures of the past three years. They had shown the issue was shrinking, but that may just have reflected lax enforcement and reporting. The country’s farmland has continued to be eaten up by industrialization and urbanization. It has shrunk by 6% over the past decade to 122 million hectares, barely above the minimum arable land the ministry reckons China needs to be self-sufficient in food. The summer’s floods and the drought earlier in the year in some parts of the country have reduced that margin further.

China has been cracking down hard on facilities operating outside China’s zoning laws:

The ministry has hit five companies so far this year for illegal land use, following a tougher inspection regime launched in February that found examples of illegal land use in more than half the 13 cities examined in an initial spot check and officials cooking the books in four. In those cases buildings were ordered to be demolished, land taken back, executives imprisoned and official reprimanded.

This post concludes by noting that none of the companies previously sanctioned were as high profile as BYD and then wonders” how tough the ministry will be this time” and what sort of signal will it want its ruling to send?

Bottom Line:
 If China is going after Chinese companies for putting manufacturing facilities on agricultural land, what in the world makes you as a foreign company think you will be able to get away with doing the same thing? And it is not just agricultural land. I am aware of a big China city office building that was recently shut down because it was zoned for a hospital only.

What are you seeing out there?

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