I am always saying that for every 100 China WFOEs and Joint Ventures my law firm helps set up in China, it does one representative office. Why so few, when it is generally agreed that representative offices are the easiest type of offices for foreign firms to set up in China? Because the inherent limitations on China Rep Offices mean they seldom make sense.
Rep Offices “represent” in China the foreign company back home. Rep Offices are not a separate legal entity; they are the China representative of the foreign company. Most importantly, they are not allowed to engage in profit making activities. Chinese law limits them to performing “liaison” activities. They cannot sign contracts or bill customers. They cannot supply parts and after-sales services for a fee. NOTE: This post does not discuss branch offices for banks, insurance companies, accounting and law firms, that are permitted to engage in profit-making activities.
Rep Offices are pretty much limited to engaging in the following:
- Conducting research.
- Promoting their foreign company.
- Coordinating their foreign company’s activities in China.
- Other activities that do not and are not intended to generate a profit.
Because forming a Rep Office in China is faster, cheaper and easier than forming a Wholly Foreign Owned Entity (WFOE), companies oftentimes consider forming a China Rep Office as a way of “putting their toe into the water” there. These companies typically intend to switch over to a WFOE once it becomes clear China will be viable for them.
My law firm’s China company lawyers generally discourage this “Rep Office and then a WFOE plan” because “switching” from a Rep Office to a WFOE is not really a switch at all. Making that switch in China will involve both shutting down the Rep Office and then forming a WFOE pretty much from scratch. Because the cost of forming a Rep Office, shutting down the Rep Office, and forming a WFOE, will be considerably more than just forming a WFOE, forming a Rep Office with the later intention of forming a WFOE does not usually make sense and most companies will be better off just biting the bullet and forming the WFOE straight away.
Other times, companies have come to my law firm believing they need a China Rep office because they need a Chinese entity to sell their product into China. Oftentimes these companies can sell their product into China without having to create any in-china footprint at all. So long as they are not going to have much need for people in China, they oftentimes can get away without forming a company in China at all.
But there are definitely times where a Rep Office makes sense. By way of one example, my firm set up a Rep Office for a US company that sells US made equipment for around $2 million each. This company has no plans to start manufacturing its equipment in China so there would be no need to form a WFOE for that. It already had an arrangement with a Chinese company to repair its equipment sold into China, so no need to establish a WFOE for that purpose either. This company merely wanted an on the ground China presence to improve its sales and to let its customers and potential customers know it is serious about China.
China Rep Office applications typically go through the Administration of Industry and Commerce (“AIC”), though some industries (banking, insurance, legal, accounting, airline, media, and some others) also require an additional approval from the Chinese government agency with jurisdiction over that particular industry. All applications must be submitted by a designated/authorized Chinese agent (often known as a Foreign Enterprise Services Company or “FESCO”) in the locality where the proposed representative office is to be established.The application involves submitting fairly standard corporate documents from the foreign company, along with a copy of the lease agreement showing the Rep Office is leasing legitimate business space in China.
MOFCOM usually takes around thirty days to approve a Rep Office. One interesting feature of China Rep Offices is that they are not permitted to hire employees directly; they must be staffed indirectly through a FESCO. Nonetheless, it remains the responsibility of the Rep Office to make sure its FESCO employees have signed off on Rep Office company policies, including on such things as confidentiality. In all instances where we have formed a China Rep Office for our clients, we also have drafted the employment agreements the FESCO must use with the employees. That way we can be certain the agreements best protect our client.