China today announced that it will be ridding China of unreliable people and companies. See China is establishing an ‘unreliable entities’ list that will include companies and people. Specifically, China’s Ministry of Commerce announced it will kick out of China “foreign enterprises, organizations and individuals that do not comply with market rules, violate the spirit of contract, block or cut supplies to Chinese firms with non-commercial purposes, and seriously damage the legitimate rights and interests of Chinese enterprises.”
What exactly does this mean for your company if it is doing business in China? What can you do to reduce the risk of being deemed unreliable and being booted out of the country?
If past performance is any indicator of future performance — and I firmly believe it is — we know well what foreign companies must do to avoid China problems going forward and we set out those things below. Before anyone panic (too much), let me just say that for the past decade or so, China has consistently gotten tougher on foreign businesses in China that are not operating legally there and though this announcement is a really big deal, it is more a change in scope than it is in kind.
In fact, two days ago, in How to React to a China Economy in Decline, I listed out 8 things our international lawyers were seeing that indicate China’s economy is in decline. Item number one was the following:
The number of foreign companies getting into legal trouble in China. Whenever China’s economy slows, its government starts looking for foreign companies out of compliance with Chinese laws. It does this both to show its citizens that it is working on their behalf and to raise money by collecting on unpaid taxes, with interest and oftentimes steep penalties. In particular we are seeing yet another increase in China going after foreign companies doing business in China without a WFOE. See Doing Business in China Without a WFOE: Will the Defendant Please Rise and China’s Tax Authorities Want You.
For at least the last six months it has been apparent to our China lawyers that China was tightening its legal enforcement against foreign companies. We also have been hearing of tightened enforcement against individuals as well, as reflected by the following:
1. Many foreigners getting arrested for being in China on the wrong visa and put in jail for 30 days and then deported.
2. Cities paying Chinese citizens to report to the authorities foreigners in China illegally.
3. Chinese police going to nightclubs and rounding up foreigners and then cutting their hair for drug testing. I have a good friend who asked that we tell people who consume cannabis not to go to China unless and until they are certain that their hair would no longer test for it.
What concerns me most about this latest announcement is that some companies operating 100% legally in China are going to get pushed out simply because of who they are and for that there likely is little to no cure. Foreign companies in industries that China has never liked may be getting notices to leave. Companies involved with movies or newspapers or books come to mind. Foreign tech companies that compete with Huawei or some other greatly favored Chinese company may also get that notice. Foreign companies that know too much about China’s government or economy or citizen sentiment are also likely going to be at greater risk. American and Canadian companies are going to be at greater risk. Companies and countries that side with (or appear to side with) the United States’ ban on Huawei or even the United States in general are also likely going to be at greater risk as well.
But because all foreign companies and individuals not in full compliance with China’s laws are at great risk our advice to every foreign company and every foreign individual in China right now is to do whatever it takes to quickly clean up your company compliance issues and consider having foreign personnel live and work elsewhere until this all blows over, if it ever will.
Foreign companies doing business in China should do some or all of the following to best weather this big storm:
Make sure your WFOE or your Joint Venture or your Representative Office actually exists and is still licensed to do the business it is doing in China. Make sure it is current on its capital obligations. See Doing Business in China Without a WFOE: Will the Defendant Please Rise.
1. Make sure your WFOE or your Joint Venture or your Representative Office is properly licensed to do business in every city in which it is doing business. It is shocking how often this is not the case.
2. Make sure your company is doing everything correctly with its employees. Consider an employer audit and note that our China employment lawyers have never done an employer audit without finding multiple problems.
3. Make sure your company is current with its taxes. If you think it may not be, it almost certainly is not.
4. Review your lease agreement and relevant zoning rules. Are you renting from a real landlord? Is it really legal for your business to do what it is doing where it is doing it?
5. Have a trusted China contract lawyer review your contracts related to your China operations to make sure all of them are legal.
6. Conduct due diligence on your suppliers/manufacturers, distributors, retailers, and e-commerce platforms. Your risks are influenced by the company you keep.
7. Make sure your IP has been properly registered and your company is not violating a China company’s IP rights.
8. If your WFOE or your Rep Office or your Joint Venture share is American or Canadian or Australian owned, consider forming a new company (“Newco”) in a country with good relations with China and selling the WFOE Joint Venture share or Rep Office package to that Newco.
I could go on and on. None of these things are new, but with today’s chilling announcement their importance has increased exponentially.
What are you seeing out there? What are you thinking? What are you going to do?
UPDATE: A China lawyer I know well and respect sent me this article (in Chinese), with the following comment: Here is a copy of the Chinese version of the threat from the Chinese government to compile an unreliable persons/companies list. Since China already blacklists every U.S.company it does not need, this would mean a blacklist of U.S. companies it DOES need, like Qualcomm and Intel and related.