International Law Realities: The 90-10 Rule.

China company formation risks

A few weeks ago, a client asked our law firm to handle a relatively routine domestic matter for them. We told them we do not handle such matters and we gave them a short list of excellent attorneys that do. The client expressed surprise at our unwillingness to take on their matter and remarked on how this area of law is “so easy.” I told them it is “easy” 90% of the time, but difficult the other 10% of the time and that we only knew enough to be able to know about half the time when we would be delving into the other 10%. In other words, we would probably have a 5% error rate and that precluded us from taking on such matters.

Yesterday, the client called to thank us because its matter was one of the ten percent. Though both the client and I had assumed the client needed A, it turned out it was in the 1% that actually would be much better off going with B.

The percentages above are guesstimates used to prove the point that many things lawyers do appear to be and in fact are fairly routine, but for any given project there is usually the ten percent, and it is that ten percent that usually causes the problem.

Law firms tend to see a large number of the ten percent because we virtually never get calls from someone saying, “I just did this and it all worked out fine, can you help me?” Our typical call is more along the lines of “the Chinese government just did this to me, is there any way you can help me?”

Forming a WFOE or a Rep Office in China is an excellent example of the 90-10 rule, both because many people are not aware of the 10% and because the problems that arise from this lack of awareness can be absolutely huge.

Ninety percent of the time (a guesstimate), forming a WFOE or an RO in China is not that complex. But it is the ten percent that will kill you.

Here are some of the ten percent issues relating to China company formation on which we have been called:

  • American company that had been locally approved for its WFOE to do X was being shut down by Beijing 15 months after its formation because X cannot be done by WFOEs in China. The “funny” thing about what this American company was doing was that had it actually defined it a bit differently (and actually more accurately) in its WFOE application, it would have been legal and it almost certainly would not have been shut down. For more on how important it is to get the right scope when applying to form a WFOE, check out “How To Form a China WFOE. Scope Really Really Matters.
  • A European company that had formed a Representative Office in China and then was told around three months later that it was operating completely illegally and would need to shut down. The European company explained to one of our China company formation lawyers what it was doing in China and without any doubt what they were doing was absolutely illegal for Rep Offices. We asked why they had opened the RO in the first place and their response was that they had done so because it was cheaper than opening a WFOE. They had never consulted an attorney on the differences between Rep Offices and WFOEs; they had simply gone to an entity formation company and instructed it to form a Rep Office and it did so. For some very basic information on the differences between Rep Offices and WFOEs, check out China Representative Offices :Got WFOE” and How To Form a China Representative Office.
  • Then there are the countless calls we have received from companies who have had their China WFOE or RO application declined or get stuck in the system. We consider these people lucky because what has happened to them beats getting approved locally and then getting shut down by Beijing. For them we formulate a plan to reinvigorate their existing application or to start all over. Once a company starts having company approval problems, a red flag gets attached to them and so even if they completely clean up their act, they will likely be subject to increased scrutiny. For this reason, where possible, we often recommend starting all over, using a new foreign company as the ownership entity.

We also often see this ten percent rule with China trademarks. Probably 90 percent of the time they are not terribly complicated, but our law firm often gets contacted with the ten percent. Last month, an American company came to us after having waited nearly a year to get its China trademark and then learning its trademark had not been approved because it had sexual connotations. In the meantime, another company had secured and begun using another portion of this American company’s brand name — the portion this American company should have trademarked in China — and its business was sinking because of it. It was the complicated ten percent and neither it nor the online trademark service it used had any clue.

Have you ever been the ten percent? If so, we’d love to hear from you below.

3 responses to “International Law Realities: The 90-10 Rule.”

  1. Thanks Dan. I am in the process of registering my HK Company (should be doing it this Monday in fact), which I intend to follow up with a rep. office, so the information here is extremely useful. I have been reading your blog for a while now and its a great resource for Expats doing business in China.
    Just one quick question, you mentioned that in order to open a rep. office, the “foreign parent” company should be at least 2 years. If its 2 years old, are they able to recruit foreign employees, or is it true that in order to recruit foreign nationals (Non-Chinese) the parent company needs to be at least 3 years old?

  2. Good post, Dan.
    How does it work -shutting down by Beijing?
    An inspection,a jubao from that American company’s kind competitor or anything else? I thought if business size does not go over certain figures, local administration for/of industry and commerce is fully in charge and Beijing just does not care. Or business scope was very specific in this case?

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