It’s Your Business, Not Your Chinese Partner’s

China partnership joint ventures

If you are a foreign business, it will not be easy or cheap for you to set up a business to operate legally in China. The following is just the most basic of lists of what you need to do to set up and operate legally in China:

  1. Register your legal entity in China. This will typically be a WFOE, a Rep Office or a Joint Venture.
  2. Lease property that will permit your company registration to go through.
  3. Enter into written employment agreements with all your employees. You should have Employer Rules and Regulations (aka an employee manual) as well.
  4. Figure out and pay all your taxes, including all taxes and mandatory benefits on your employees.

Complying with the above will not be cheap or easy, but it is necessary.

Our China business lawyers have lately been seeing an increase in foreign companies setting up “quickly and cheaply” in China through their Chinese “partners.” And with that, our China business lawyers are also seeing a whole host of foreign companies with major legal problems in China.

Let me explain.

As China is becoming wealthier, its need for service businesses is growing and it is almost exclusively in the service sector that we are seeing this troubling new trend. We usually “see” this when the Western service company asks us to “review” its contract with its Chinese partner and we immediately realize the Western service company needs a heck of a lot more than that.

Here is what is happening. The Western service company goes over to China and gets wooed by a Chinese service company, usually in the same or an allied industry. The Chinese service company convinces the Western service company there is a huge demand in China for the services the Western service company can provide — this part is easy, because there almost is that huge demand. The Chinese company then convinces the Western service company that their two companies should “work together” to market their services in China.

The Chinese company then convinces the Western company that it (the Chinese company) will handle “everything” and get the Western company up and running in a few weeks. The Chinese company then has the Western company lease some space from the Chinese company and the Chinese company even hires a couple Chinese employees on behalf of this putative joint venture. To top it all off, the Chinese company puts the Western company’s name and logo on the door and, voila, the Western company now has a business in China.

Except it doesn’t.

I get the sense that the people contacting us on doing some sort of workaround to avoid having to form a China company are hoping they somehow have found THE loophole that nobody else has found and that if they can get the blessings of one attorney for what they are doing, their operating illegally in China will somehow not be “so” illegal. I wish I had some magic oil I could sprinkle on these illegal China businesses to make them legal, but there is no such thing.

Those who think they are going to become “sort of” legal by operating illegally in China are obviously wrong and going into China via some “half-legal” method is not only riskier than operating legally, but also riskier than operating completely illegally.

As lawyers, we are never going to tell our client to go “full illegal,” but in my role as a blogger, I can tell you that operating completely illegally in China usually makes better sense than paying a lawyer to draft a void or invalid contract. I think people know this, but their rightful discomfort at operating illegally makes them want to clutch on to something that will allow them to justify (however falsely) their actions.

The same holds true with respect to forming a Rep Office when a WFOE is required. Forming the Rep Office in that situation will just serve to let the Chinese government know where you are and what you are doing and will make it easy for them to realize that what you are doing requires a WFOE. On top of that, as I am always saying, you should not form a Rep Office with plans to form a WFOE in a year or so “if everything works out.” You should not do this because you will end up paying THREE times as you will pay for forming the Rep Office, pay for shutting down the Rep Office (and this is not cheap), and then pay for forming the WFOE.

What really drives me crazy about all this though is that on at least three occasions, companies for whom we have refused to form Rep Offices have written me to tell me that “so and so” company formation company is willing to form the Rep Office for them, as though this mere fact means that my firm was wrong in declining to take money to do something we know will eventually not work.

And though I take no happiness from this, I will note that one of the three companies that went ahead and formed a Rep Office against our advice did contact us about a year later to tell us that the Chinese government was now making them form a WFOE. [UPDATE — After I wrote this post, a company contacted me to let me know that their illegal Rep Office had been shut down within three months of its having been formed. All it took was one knock on their door to be discovered as having too many employees for a Rep Office!]

These quasi-partnerships with Chinese companies are the same sort of thing as forming a Rep Office when a WFOE is required, and having a relationship with a Chinese entity is not going to help you when the Chinese government discovers you are operating illegally. It is also not going to help you if one of your employees sues you and is able to point out that you do not really exist in China.

In fact,  your relationship with the Chinese entity is likely to hurt you in your dealings with the Chinese government and overall.

Whenever I learn of these “fake” joint ventures, the first thing I suggest is that the Western company immediately register its trademarks in China because it is using them already, but without any protection. More than once, one of these Western companies has assured me that everything was fine because their Chinese partner had registered their trademarks, only for us to learn that the Chinese companies had registered the Western company’s trademarks in their own names and not in the names of the Western company.

My biggest fear with these so-called partnerships is that when they become really successful, the Chinese company will either directly or indirectly (through the Chinese government), boot out their Western “partner.” And when that happens, the Western partner will not have any legal recourse to stop its Chinese partner from taking over the business. I mean, if the Western partner is going to sue its Chinese partner, what will it even say?  “Your honor, I know my business was here in China completely illegally, but that is because legally starting a business in China is just so difficult and expensive, but now that the business is worth millions, it just is not fair for me to get kicked out of it and for my Chinese partner to get the whole thing.”

Good luck with that.

I will note that every single time we have been retained by the Western partner to clean up this sort of situation in China, their Chinese partner insists the whole time that what we are doing is a complete waste of time and money. But what else would you expect them to say?

What are you seeing out there?

32 responses to “It’s Your Business, Not Your Chinese Partner’s”

  1. “Go full illegal rather than part illegal in China” I think is the take home quote. Good advice. I need to digest that for awhile.

  2. “Go full illegal rather than part illegal in China” I think is the take home quote. Good advice. I need to digest that for awhile.

  3. “Spot on,” as the British would say. I just wrote an article in which I noted that if you are not prepared to set up your business in China corrrectly from the start, with a proper strategic plan in place, and then to take all the needed and appropriate steps, then you should seriously reconsider whether you are really prepared to go through with this endeavor at all. First, the days of China being the “unregulated wild West” are long gone, and now as wages, energy costs, regulations and the RMB all cause products to be more expensive, the days of making a quick and easy buck are gone, too. So if you’re not going to do this right, then at best, a business will only reap a tiny percentage of what might otherwise be out there, and at worst, can have its “clock cleaned” both in business and by the law. And it can even lose its brand in the process.
    I was asked by a local lawyer (another city) to speak with a North American clothing retailer who was being urged to open a rep office in Shanghai (huh?) by a Hong Kong individual who claimed to know all about the company’s industry, suppliers and (of course) Mainland laws. It was even worse than this, but to be briefish, I wasted a couple of hours trying to dissuade this person from making such an enormous (and obvious) mistake–the purpose would be to centralize all purchasing in China, and to have inspection and assembly of materials there (and maybe even some sales), so it would have employees, a warehouse, shipping, many contracts, etc. I finally realized that as he was to fly to Shanghai in the next 48 hours, essentially he had already made up his mind; I suppose he’d been warned that lawyers would tell him that he would need to take all sorts of formal, expensive and time consuming measures with strategic plans, IP, WFOEs and employment laws and so on, but that this one guy from HK could somehow handle everything on the cheap via a Rep Office. Dan, should I send him to you when his Rep Office gets shut down?!

  4. David,
    Don’t send him to me. Two reasons. One, if he wasn’t willing to spend the amount needed to do it right in the first place, he sure isn’t going to be willing to spend 5 times that for me to try to save his ass. Second, I don’t believe there would be anything we could do. The only reason to send him to me is so I can quote him a super high rate and then tell him that we have only around a five percent chance of being able to help him at all. I used to feel bad about telling people that, but in situations like this….oh, I had better not say it.

  5. “Spot on,” as the British would say. I just wrote an article in which I noted that if you are not prepared to set up your business in China corrrectly from the start, with a proper strategic plan in place, and then to take all the needed and appropriate steps, then you should seriously reconsider whether you are really prepared to go through with this endeavor at all. First, the days of China being the “unregulated wild West” are long gone, and now as wages, energy costs, regulations and the RMB all cause products to be more expensive, the days of making a quick and easy buck are gone, too. So if you’re not going to do this right, then at best, a business will only reap a tiny percentage of what might otherwise be out there, and at worst, can have its “clock cleaned” both in business and by the law. And it can even lose its brand in the process.
    I was asked by a local lawyer (another city) to speak with a North American clothing retailer who was being urged to open a rep office in Shanghai (huh?) by a Hong Kong individual who claimed to know all about the company’s industry, suppliers and (of course) Mainland laws. It was even worse than this, but to be briefish, I wasted a couple of hours trying to dissuade this person from making such an enormous (and obvious) mistake–the purpose would be to centralize all purchasing in China, and to have inspection and assembly of materials there (and maybe even some sales), so it would have employees, a warehouse, shipping, many contracts, etc. I finally realized that as he was to fly to Shanghai in the next 48 hours, essentially he had already made up his mind; I suppose he’d been warned that lawyers would tell him that he would need to take all sorts of formal, expensive and time consuming measures with strategic plans, IP, WFOEs and employment laws and so on, but that this one guy from HK could somehow handle everything on the cheap via a Rep Office. Dan, should I send him to you when his Rep Office gets shut down?!

  6. My company has a large, foreign competitor that formed local entities in the name of the Chinese wife of a senior staff member to run their China operations. While I have no doubt it has saved them a significant amount of money in compliance costs (tax, social insurances, set up costs etc), it has also exposed them to significant risk and flagrant abuse. The couple in question rakes off a lot of money by overcharging foreign HQ for just about every activity the local entity undertakes. The competitor discovered it couldn’t get work visas for foreign national staff (including the senior manager in question who lives in China on a ‘no work’ L Visa as the spouse of a Chinese national) and had to set up a separate WOFE and office just to employ their foreign managers. Internal abuse and corruption are rife, including bribery of staff of channel partners. Foreign HQ chooses to turn a blind eye to all of this.
    In the end, foreign HQ has lost control of their China business. It is almost certainly spending more money operating this way than having initially set up a fully compliant WOFE. It is not in a position to get rid of the foreign senior manager or retake control of their business.
    Operating illegally is simply not interesting or worth it. While fully compliant WFOE’s are difficult to form and operate and compliance costs are high, it keeps life very simple and minimises risk for both HQ and the China operation.

  7. David,
    Don’t send him to me. Two reasons. One, if he wasn’t willing to spend the amount needed to do it right in the first place, he sure isn’t going to be willing to spend 5 times that for me to try to save his ass. Second, I don’t believe there would be anything we could do. The only reason to send him to me is so I can quote him a super high rate and then tell him that we have only around a five percent chance of being able to help him at all. I used to feel bad about telling people that, but in situations like this….oh, I had better not say it.

  8. So I have a willing Chinese partner. What is the time line, with your group’s involvement, to make ourselves (the US end) legal in China?

  9. Aric: Certainly foreign companies can form partnerships with Chinese companies.
    Only under certain complicated legal restrictions.
    Aric: Where is the line between having a Chinese partner who does things for you, and operating illegally in China?
    The main worry is not that the police will arrest you and put you in jail. That *is* a worry, but that’s not the main worry. The main worry is that if you don’t to things by the book, then it’s not your business. If you have a Chinese “partner” then one day you will wake up and you’ll find that legally he has everything, and you have nothing, because without going through the proper procedures, it’s his business and not yours.
    Dan: I mean, if the American/Western partner is going to sue its Chinese partner, what will it even say?
    It can be even worse than that. If you haven’t done things correctly then legally you don’t exist, and you can’t even get as far as filing a lawsuit.

  10. I’m making some very broad generalizations here, but I think the point is valid.
    One difference between American law and Chinese law is that American business law looks more at “intent” (what the the parties to the contract intend) whereas Chinese law looks more at “technicalities” (did the people file the right papers at the right time).
    The focus that Chinese law has on “technicalities” (did you follow the right procedure, get the right papers signed, and follow the deadlines) can be annoying to Americans that are used to a law that is based on “intent”, but there is a reason that Chinese law is structured in this way.
    Basically if you have a system that is based on “intent” that gives a lot of power to judges to interpret and reinterpret things, and this allows for a lot of “funny business” if you have judges that may be subject to either corruption or political pressure. If the outcome of the case depends on the judge figuring out what the parties intended, and they judge is subject to political pressure or corruption, then I’m probably dead, because the judge can and will rewrite things against my interests. The big problem is that if the judge rules against me, it’s not obvious that there was political pressure or corruption even if there was. Also, even if there *wasn’t* political pressure or corruption, people will think that there is which makes it harder for people to trust the system.
    However, if the outcome of a case depends on whether or not you got a piece of paper stamped, and you can show that piece of paper, then there is less room for funny business. We go to court, I show that I have that piece of paper stamped and all of the technicalities are in order and the either judge has to rule in my favor or else we know that there is funny business and we can take it to a higher level.
    There is one area of law in which US law does resemble Chinese law and that is with motor vehicle registrations. (And don’t take this analogy too far, or use it for anything “real”.) If you want to sell me a car, you have to give me the title to the car so that I can go to the DMV to register title. If I give you money, but you refuse to give me that piece of paper saying that the car is mine, then it’s going to be very difficult for me if three years down the line, you drive off with the car.

  11. I hope you can clarify something for me. I understand that setting up a RO of WFOE incorrectly can cause problems. I also see how a foreign company can loose out if a real or fake JV goes wrong. I don’t understand what you mean when you say that operating with a Chinese partner is operating illegally. Certainly foreign companies can form partnerships with Chinese companies. Where is the line between having a Chinese partner who does things for you, and operating illegally in China?

  12. One other issue is the definition of “illegal.”
    Broadly speaking, under US law, anything that isn’t prohibited is allowed. Under PRC law, anything that isn’t allowed is prohibited.
    So in US law, when you are looking for something “illegal” what you do is to find a law that says that you can’t do what you are doing. In China, you aren’t supposed to do something unless you can find a law that specifically allows what you are doing. So if you can’t find a law on the topic, then in the US you can go ahead and do it. In PRC, if you can’t find a law that specifically allows you to do what you are doing, then you aren’t supposed to be doing it. (And if you find a law that specifically bans what you are doing to do, then it’s really bad.)
    Now what happens if you find yourself in “no law land” is messy. One problem with doing something without legal sanction in the PRC is that since there is no law on the topic, it’s not clear what happens if you do what you are trying to do. One thing that is changing is that over time, the situations that aren’t covered by law are decreasing.
    There have been situations where people have done things that weren’t authorized by the law, but later on they changed the law to authorize what they were doing, but as time passes and the laws get more developed, that’s less and less likely to happen. Also as Chinese law develops, the likelihood that by doing something that merely isn’t authorized forces you to do something that really, really get you in trouble (i.e. not pay employment taxes) increases.
    Dan: But if you are going to have an office in China and/or employees in China, then you need a company in China.
    You can structure things so that you don’t have an office in China and you don’t have any employees in China, and everything is in the hands of your partner. That’s fine, as long as you realize that you don’t have a business in China. The partner can apply for a work visa for you, arrange manufacturing, etc. etc., but at that point he isn’t really your “partner” but rather your employer. That’s fine as long as you realize that this is what the situation is.

  13. My company has a large, foreign competitor that formed local entities in the name of the Chinese wife of a senior staff member to run their China operations. While I have no doubt it has saved them a significant amount of money in compliance costs (tax, social insurances, set up costs etc), it has also exposed them to significant risk and flagrant abuse. The couple in question rakes off a lot of money by overcharging foreign HQ for just about every activity the local entity undertakes. The competitor discovered it couldn’t get work visas for foreign national staff (including the senior manager in question who lives in China on a ‘no work’ L Visa as the spouse of a Chinese national) and had to set up a separate WOFE and office just to employ their foreign managers. Internal abuse and corruption are rife, including bribery of staff of channel partners. Foreign HQ chooses to turn a blind eye to all of this.
    In the end, foreign HQ has lost control of their China business. It is almost certainly spending more money operating this way than having initially set up a fully compliant WOFE. It is not in a position to get rid of the foreign senior manager or retake control of their business.
    Operating illegally is simply not interesting or worth it. While fully compliant WFOE’s are difficult to form and operate and compliance costs are high, it keeps life very simple and minimises risk for both HQ and the China operation.

  14. So I have a willing Chinese partner. What is the time line, with your group’s involvement, to make ourselves (the US end) legal in China?

  15. Aric: Certainly foreign companies can form partnerships with Chinese companies.
    Only under certain complicated legal restrictions.
    Aric: Where is the line between having a Chinese partner who does things for you, and operating illegally in China?
    The main worry is not that the police will arrest you and put you in jail. That *is* a worry, but that’s not the main worry. The main worry is that if you don’t to things by the book, then it’s not your business. If you have a Chinese “partner” then one day you will wake up and you’ll find that legally he has everything, and you have nothing, because without going through the proper procedures, it’s his business and not yours.
    Dan: I mean, if the American/Western partner is going to sue its Chinese partner, what will it even say?
    It can be even worse than that. If you haven’t done things correctly then legally you don’t exist, and you can’t even get as far as filing a lawsuit.

  16. I’m making some very broad generalizations here, but I think the point is valid.
    One difference between American law and Chinese law is that American business law looks more at “intent” (what the the parties to the contract intend) whereas Chinese law looks more at “technicalities” (did the people file the right papers at the right time).
    The focus that Chinese law has on “technicalities” (did you follow the right procedure, get the right papers signed, and follow the deadlines) can be annoying to Americans that are used to a law that is based on “intent”, but there is a reason that Chinese law is structured in this way.
    Basically if you have a system that is based on “intent” that gives a lot of power to judges to interpret and reinterpret things, and this allows for a lot of “funny business” if you have judges that may be subject to either corruption or political pressure. If the outcome of the case depends on the judge figuring out what the parties intended, and they judge is subject to political pressure or corruption, then I’m probably dead, because the judge can and will rewrite things against my interests. The big problem is that if the judge rules against me, it’s not obvious that there was political pressure or corruption even if there was. Also, even if there *wasn’t* political pressure or corruption, people will think that there is which makes it harder for people to trust the system.
    However, if the outcome of a case depends on whether or not you got a piece of paper stamped, and you can show that piece of paper, then there is less room for funny business. We go to court, I show that I have that piece of paper stamped and all of the technicalities are in order and the either judge has to rule in my favor or else we know that there is funny business and we can take it to a higher level.
    There is one area of law in which US law does resemble Chinese law and that is with motor vehicle registrations. (And don’t take this analogy too far, or use it for anything “real”.) If you want to sell me a car, you have to give me the title to the car so that I can go to the DMV to register title. If I give you money, but you refuse to give me that piece of paper saying that the car is mine, then it’s going to be very difficult for me if three years down the line, you drive off with the car.

  17. @Aric,
    Great question. Operating with a Chinese partner is illegal if you are doing business in China without your own separate entity. A foreign based company can buy from Chinese companies without having to form a Chinese company, no problem. But if you are going to have an office in China and/or employees in China, then you need a company in China. It isn’t so much the Chinese partner that matters, it is what you are doing in China that matters. If you are flying over there every couple of months for a few days and if you don’t have an office there and if you don’t have employees there, you are probably okay. But if you have an office or employees or you are living there or selling product there or manufacturing there, then you are doing business there and you need your own legal entity and what you are doing with your Chinese partner isn’t going to help you at all on that.

  18. One other issue is the definition of “illegal.”
    Broadly speaking, under US law, anything that isn’t prohibited is allowed. Under PRC law, anything that isn’t allowed is prohibited.
    So in US law, when you are looking for something “illegal” what you do is to find a law that says that you can’t do what you are doing. In China, you aren’t supposed to do something unless you can find a law that specifically allows what you are doing. So if you can’t find a law on the topic, then in the US you can go ahead and do it. In PRC, if you can’t find a law that specifically allows you to do what you are doing, then you aren’t supposed to be doing it. (And if you find a law that specifically bans what you are doing to do, then it’s really bad.)
    Now what happens if you find yourself in “no law land” is messy. One problem with doing something without legal sanction in the PRC is that since there is no law on the topic, it’s not clear what happens if you do what you are trying to do. One thing that is changing is that over time, the situations that aren’t covered by law are decreasing.
    There have been situations where people have done things that weren’t authorized by the law, but later on they changed the law to authorize what they were doing, but as time passes and the laws get more developed, that’s less and less likely to happen. Also as Chinese law develops, the likelihood that by doing something that merely isn’t authorized forces you to do something that really, really get you in trouble (i.e. not pay employment taxes) increases.
    Dan: But if you are going to have an office in China and/or employees in China, then you need a company in China.
    You can structure things so that you don’t have an office in China and you don’t have any employees in China, and everything is in the hands of your partner. That’s fine, as long as you realize that you don’t have a business in China. The partner can apply for a work visa for you, arrange manufacturing, etc. etc., but at that point he isn’t really your “partner” but rather your employer. That’s fine as long as you realize that this is what the situation is.

  19. What you describe is pretty much exactly what happened to me and when I went to an attorney to sue and he looked at my papers he told me I had nothing and no chance. I am still young so I am starting all over, doing things right this time and by myself too.

  20. So I’m very much “the guy” described in this and related posts, planning to do business in China with the fiancée and her brother. My ultimate question is “how much would it cost to come in and have you shoot holes in my plan?” Basically, we’re set up as a US LLP, with my Chinese partners holding a minority share. Their role is to build and operate a website in mainland China. They have an office and they will hire employees. The partnership (me in the US) has applied for trademark protection in China and holds the domain registrations. Our agreement was reviewed by a Chinese attorney who didn’t have a problem with the Chinese partners owning a percentage of a US company. But I read here that it may be illegal.
    As per the above comment, everything would be in the hands of my Chinese partner, except the revenues, which come from the US, and the IP.
    I understand the vulnerability should a Chinese court see our setup as an attempt to circumvent requirements for foreign businesses.
    I believe we could file as a Chinese Joint Venture but not without difficulties because of the restrictions on sweat equity in a Chinese LLP.
    Thanks for bringing up these issues. I’d rather face them now. Besides, sleeping well at night is over rated.

  21. What you describe is pretty much exactly what happened to me and when I went to an attorney to sue and he looked at my papers he told me I had nothing and no chance. I am still young so I am starting all over, doing things right this time and by myself too.

  22. So I’m very much “the guy” described in this and related posts, planning to do business in China with the fiancée and her brother. My ultimate question is “how much would it cost to come in and have you shoot holes in my plan?” Basically, we’re set up as a US LLP, with my Chinese partners holding a minority share. Their role is to build and operate a website in mainland China. They have an office and they will hire employees. The partnership (me in the US) has applied for trademark protection in China and holds the domain registrations. Our agreement was reviewed by a Chinese attorney who didn’t have a problem with the Chinese partners owning a percentage of a US company. But I read here that it may be illegal.
    As per the above comment, everything would be in the hands of my Chinese partner, except the revenues, which come from the US, and the IP.
    I understand the vulnerability should a Chinese court see our setup as an attempt to circumvent requirements for foreign businesses.
    I believe we could file as a Chinese Joint Venture but not without difficulties because of the restrictions on sweat equity in a Chinese LLP.
    Thanks for bringing up these issues. I’d rather face them now. Besides, sleeping well at night is over rated.

  23. Jon: Our agreement was reviewed by a Chinese attorney who didn’t have a problem with the Chinese partners owning a percentage of a US company. But I read here that it may be illegal.
    It’s not prohibited for a Chinese national to be part of a US LL.P. The big problem is currency restrictions. They aren’t going to be easily be able to convert their RMB into USD which you will need for the company, and if their money isn’t in US dollars in a US bank, they it’s pretty useless to you.
    Jon: Our agreement was reviewed by a Chinese attorney who didn’t have a problem with the Chinese partners owning a percentage of a US company.
    Who was the lawyer working for? If the lawyer was hired by the partnership or by your partners, then he has no legal responsibility to protect your interests, and in some situations they may be giving advice the works against your interests. Also, if it’s a Chinese lawyer in China, and it turns out that he has given bad legal advice that screws you over, you have no recourse.
    What did you ask the lawyer? There is a cultural difference between Chinese lawyers and US lawyers in that Chinese lawyers will tend to answer the question that you ask them, whereas a US lawyer will figure out what question you should be asking. For example, if you ask “is this agreement legal?” A Chinese lawyer will tend to answer “yes, it’s legal.” A US lawyer is more likely to answer “yes it’s legal, but it will end up bankrupting you if you sign it, and it’s irrelevant anyway to what you are trying to do.”
    What are you bringing to the table? Are you bringing capital? Technology? Social connections? One problem is if the “value added” involves knowing the US market and bringing in customers. The problem is that in a few years, your partners will understand the US market and they will have access to the customer lists. What happens then?
    What are they bringing to the table? It’s not obvious what’s in it for them. If they are just running the servers then why not just outsource the work.
    Jon: As per the above comment, everything would be in the hands of my Chinese partner, except the revenues, which come from the US, and the IP.
    What’s keeping your partner from firing you, taking everything and setting up a competing business? If they control the servers in China, where does that leave you?
    Also how much is the IP really worth? If you are Coca-Cola, then it’s going to be hard for them to set up a competing business under a different name. But if you were some brand like Google or Coca-Cola I suspect that you wouldn’t be asking questions here. If you have some brand that no one has ever heard of, then the trademark is not going to be worth much, and there is nothing that keeps them from setting up a competing brand.
    Jon: I understand the vulnerability should a Chinese court see our setup as an attempt to circumvent requirements for foreign businesses.
    I don’t think that is the big vulnerability. The big vulnerability is “how much do you really trust the people you are doing business with, and what happens if they try to stab you in the back?”

  24. Jon: Our agreement was reviewed by a Chinese attorney who didn’t have a problem with the Chinese partners owning a percentage of a US company. But I read here that it may be illegal.
    It’s not prohibited for a Chinese national to be part of a US LL.P. The big problem is currency restrictions. They aren’t going to be easily be able to convert their RMB into USD which you will need for the company, and if their money isn’t in US dollars in a US bank, they it’s pretty useless to you.
    Jon: Our agreement was reviewed by a Chinese attorney who didn’t have a problem with the Chinese partners owning a percentage of a US company.
    Who was the lawyer working for? If the lawyer was hired by the partnership or by your partners, then he has no legal responsibility to protect your interests, and in some situations they may be giving advice the works against your interests. Also, if it’s a Chinese lawyer in China, and it turns out that he has given bad legal advice that screws you over, you have no recourse.
    What did you ask the lawyer? There is a cultural difference between Chinese lawyers and US lawyers in that Chinese lawyers will tend to answer the question that you ask them, whereas a US lawyer will figure out what question you should be asking. For example, if you ask “is this agreement legal?” A Chinese lawyer will tend to answer “yes, it’s legal.” A US lawyer is more likely to answer “yes it’s legal, but it will end up bankrupting you if you sign it, and it’s irrelevant anyway to what you are trying to do.”
    What are you bringing to the table? Are you bringing capital? Technology? Social connections? One problem is if the “value added” involves knowing the US market and bringing in customers. The problem is that in a few years, your partners will understand the US market and they will have access to the customer lists. What happens then?
    What are they bringing to the table? It’s not obvious what’s in it for them. If they are just running the servers then why not just outsource the work.
    Jon: As per the above comment, everything would be in the hands of my Chinese partner, except the revenues, which come from the US, and the IP.
    What’s keeping your partner from firing you, taking everything and setting up a competing business? If they control the servers in China, where does that leave you?
    Also how much is the IP really worth? If you are Coca-Cola, then it’s going to be hard for them to set up a competing business under a different name. But if you were some brand like Google or Coca-Cola I suspect that you wouldn’t be asking questions here. If you have some brand that no one has ever heard of, then the trademark is not going to be worth much, and there is nothing that keeps them from setting up a competing brand.
    Jon: I understand the vulnerability should a Chinese court see our setup as an attempt to circumvent requirements for foreign businesses.
    I don’t think that is the big vulnerability. The big vulnerability is “how much do you really trust the people you are doing business with, and what happens if they try to stab you in the back?”

  25. Thanks for the insights and questions.
    I am insanely paranoid about competition. If I’m successful, I’m going to have copycats. It’s the Chinese way. I anticipate that and am trying to prepare. It would suck if it was from my partners, but then I’d get back a chunk of equity.
    I don’t want to lay out my whole disaster recovery plan, but I believe I can retain control of my website if there were mutiny.
    Twofish – The big vulnerability is “how much do you really trust the people you are doing business with, and what happens if they try to stab you in the back?”
    The smart-ass answer is that I’d probably break off the engagement. And seriously I’d rather know sooner than later if my trust is misplaced.
    There’s trust and then there’s trust. I trust my dogs to lay down their lives for me on the off chance I were attacked by a grizzly bear. I don’t trust them not to eat my tuna sandwich if I leave it on the coffee table and leave the room for an hour. Sure you want to trust your potential partners before you go into business. But you throw trust out the window once you’re in business.
    Twofish — It’s not prohibited for a Chinese national to be part of a US LL.P. The big problem is currency restrictions. They aren’t going to be easily be able to convert their RMB into USD …
    Thanks. That’s extremely helpful. The currency restrictions are not an issue at this point.
    Twofish – Who was the lawyer working for? If the lawyer was hired by the partnership or by your partners, then he has no legal responsibility to protect your interests …
    Point well taken. He was working for the partnership.

  26. Thanks for the insights and questions.
    I am insanely paranoid about competition. If I’m successful, I’m going to have copycats. It’s the Chinese way. I anticipate that and am trying to prepare. It would suck if it was from my partners, but then I’d get back a chunk of equity.
    I don’t want to lay out my whole disaster recovery plan, but I believe I can retain control of my website if there were mutiny.
    Twofish – The big vulnerability is “how much do you really trust the people you are doing business with, and what happens if they try to stab you in the back?”
    The smart-ass answer is that I’d probably break off the engagement. And seriously I’d rather know sooner than later if my trust is misplaced.
    There’s trust and then there’s trust. I trust my dogs to lay down their lives for me on the off chance I were attacked by a grizzly bear. I don’t trust them not to eat my tuna sandwich if I leave it on the coffee table and leave the room for an hour. Sure you want to trust your potential partners before you go into business. But you throw trust out the window once you’re in business.
    Twofish — It’s not prohibited for a Chinese national to be part of a US LL.P. The big problem is currency restrictions. They aren’t going to be easily be able to convert their RMB into USD …
    Thanks. That’s extremely helpful. The currency restrictions are not an issue at this point.
    Twofish – Who was the lawyer working for? If the lawyer was hired by the partnership or by your partners, then he has no legal responsibility to protect your interests …
    Point well taken. He was working for the partnership.

  27. what is the recourse of WFOE when its chinese employees do not honor the employment contract, e.g. when the contract states that there should be a one month prior notice but the chinese employee will insist that after telling you his resignation today tomorrow should be their last day or just escape in the night?

  28. what is the recourse of WFOE when its chinese employees do not honor the employment contract, e.g. when the contract states that there should be a one month prior notice but the chinese employee will insist that after telling you his resignation today tomorrow should be their last day or just escape in the night?

  29. I hope you can clarify something for me. I understand that setting up a RO of WFOE incorrectly can cause problems. I also see how a foreign company can loose out if a real or fake JV goes wrong. I don’t understand what you mean when you say that operating with a Chinese partner is operating illegally. Certainly foreign companies can form partnerships with Chinese companies. Where is the line between having a Chinese partner who does things for you, and operating illegally in China?

  30. @Aric,
    Great question. Operating with a Chinese partner is illegal if you are doing business in China without your own separate entity. A foreign based company can buy from Chinese companies without having to form a Chinese company, no problem. But if you are going to have an office in China and/or employees in China, then you need a company in China. It isn’t so much the Chinese partner that matters, it is what you are doing in China that matters. If you are flying over there every couple of months for a few days and if you don’t have an office there and if you don’t have employees there, you are probably okay. But if you have an office or employees or you are living there or selling product there or manufacturing there, then you are doing business there and you need your own legal entity and what you are doing with your Chinese partner isn’t going to help you at all on that.

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