China Law Blog

At the end of every year and the beginning of the new one, many (most?) blogs do a post extolling the previous year's posts, their own blog's longevity and/or ever increasing readership, and talking about how great it is to blog for such smart/astute/wonderful people, and why this blog is so different from all the other blogs out there.

I have never much liked those posts for the simple reason that I do believe most people find them terribly interesting.

But hey, when someone else pretty much gives me a forum to go off on most of this stuff and does a great job writing it all up, and when that someone is legal writer extraordinaire, "Mister Thorne,", well then, it just wouldn't be neighborly of me not to link over and tell everyone to go there if they want to find out what makes China Law Blog tick. Or not. The post is entitled, "Dan Harris -- A Flavorful Blawgger" and you should check it out.... If you think it might be interesting.

On a somewhat similar note, and seeing as how this will have to qualify as my end/beginning of year post, I would like to take this opportunity to thank all those who voted us best blog at the American Bar (as in lawyer) Association blawg election, for the second straight year. The best part about it was that we won without having to beg (too much anyway) for your votes and without having to send out blanket emails. All joking aside, your having chosen us is very much appreciated and we are truly honored.

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On January 13, from 2:00 pm until 6:00 pm, The China Economic Review will be putting on a seminar/forum, entitled, "Foreign Direct Investment in China: Optimizing FDI strategy in the current economic climate."

Do NOT miss it.

China Economic Review describes it as follows:

Foreign Direct Investment has always been a major contributor to China’s economic development, but it’s fallen for the first time. What will be the impact of the global economic downturn on China’s FDI inflows in 2009? Will China’s efforts to stimulate domestic demand be effective in attracting more investment? How will you improve your return on investment in the new economic climate?

China Economic Review has invited leading experts to talk about issues and solutions from the unique perspective of investment in mainland China. This half-day interactive and case study-oriented conference will provide valuable knowledge and practical advice on how to optimize your FDI strategy and increase returns on investment in China.

For more on this event and to register, go here.

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Of those who comment on our blog, I never remember who agrees or disagrees with me on issues, but I always remember those who make me think. That is why I remember G.E. Anderson and that is why I was so happy to learn (from Professor Donald Clarke, the brains behind the Chinese Law Professor Blog) that G.E. Anderson has just started his own blog. Anderson's blog is ChinaBizGov and its tagline is "Highlighting interesting issues in business-government relations in Greater China."

Anderson describes himself as a "China specialist, former CFO, and PhD Candidate in Political Science at UCLA. Research focuses on state-owned enterprises, corporate governance and China's auto industry."

It took me only one post to know I was going to like this blog. The post is today's post, entitled, "Privatization of Central SASAC Assets," in which Anderson talks about a conversation he recently had with a journalist out of Beijing on whether China is moving away from privatization, without really making a conclusion one way or another. This is a great issue and one I too have been struggling with. I did a post a few weeks ago, entitled, "China And The US. Which Of Us Is The Most Capitalistic?" postulating that as the US moves away from rampant capitalism, China is moving towards it. Yet, within hours of having done that post, I started having doubts regarding China's moving toward capitalism.

Is China getting more or less capitalistic? Help me out here cause I dunno.

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I was interviewed a couple weeks ago by a reporter who wanted to know what impact the declining economy in China was having on my law firm's clients. I told her none. I said that so far, anyway, not a single client had even mentioned China's declining economy as a factor in its decision-making. But I then said that I had also not really been asking and that about half our clients are not in manufacturing, and that virtually none of our manufacturing clients make low end products like $2 toys, socks, or costume jewelry. I also mentioned that less than ten percent of our manufacturing clients are in Guangdong Province, which seems to have been hardest hit.

Since that interview, I have conducted an extremely unscientific client survey regarding our clients' China plans. This survey was of about fifteen clients (to tell you how unscientific it was, I took no notes), eleven of which are American, one Korean, one Spanish, one Mexican, and one German. About half are in manufacturing and none make what anyone would describe as a low end good like a cheap toy or jewelry. I asked them how their China business was going, "in light of the economic downturn." I also asked them if the downturn was going to cause them to reduce or eliminate their China presence. Lastly, I asked them what the would be doing differently in China in 2009 due to the economic downturn. Their answers were all pretty much the same.

They said that China's downturn had made them look more carefully at their China expansion and hiring plans. They said they were going to be very "cautious" and "careful" in 2009 with respect to expansion and hiring. Many of them (5 or 6?) said they had an "official" hiring freeze in place for the first six months of 2009 or the entire year. Two said they were going to expand faster than anticipated in China because they saw now as the best time to get a jump on their less well-funded rivals. All of them said they had no concrete plans to get out of China, but one worried that the company's overall problems might force an ill-advised China exit. Many of them responded to my question about their leaving China by asking me "and go where?" I got the following comments (these are from the last few months, not just from these 15 or so companies):

1. This downturn is good. It is going to bring us stability. We had been losing 2-3 good employees every month and that has stopped completely.

2. I hated China's new labor law and I hated how employees were able to hold this over our heads. The power has shifted.

3. I have enjoyed my last six months in China more than any six month period in my 20 years here. We are a small fish in a big pond (they are in Shanghai) and I feel like the government actually appreciates that we are sticking it out and have not laid off anyone.

4. China is the only country in which our company is still doing well.

5. We had made some terrible deals because we had no choice. We have been able to renogoiate nearly all of them. Our costs are down, and our sales are down, but our profits have remained the same.

6. We looked at Vietnam and really liked what we saw, and we definitely plan to add that to our China operations eventually, but nobody wants to spend the money to get set up there right now. Maybe in a year or two.

7. I'm just glad we are no longer in Thailand.

8. Our R&D in China has been fantastic. We want to expand and we should be expanding, but the company has a complete freeze on anything new right now. I see this as a huge mistake and one that is going to cost us millions down the road.

9. Our sales are down 20% worldwide. Nobody wants to leave China because we all know we will make good money here soon, but the question is whether the home office will be able to subsidize us until we do.

Would love your comments. How is China's downturn affecting your business?

UPDATE: Make that sixteen. Had a long conversation with a client that focuses on auto parts sourcing in China, Vietnam and Mexico. Told me 2008 was best year ever and 2009 is going to be much better. Seems many of the automobile and auto parts companies have laid off so many people they are going even more outside their own doors for outsourcing. They are hiring outsourcing companies more and doing the outsourcing themselves even less.

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Recieved an email from Toronto-based international lawyer, Paul Jones, on China's just amended patent laws. I liked it so much, I secured Paul's permission to run it here:

"Last week in Beijing there was the last meeting of the Standing Committee of the National People’s Congress for 2008. On Saturday it was announced that they had found that the revisions and consultations (they received some 500 responses) had gone so well that that the amendments had been voted on and adopted. The Amendments will come into effect October 1, 2009.

The Amendments and the Amended Law (in Chinese) are here. [We will be watching for a good English language translation and will post it when and if we find it]

The amendments introduce a number of changes such as an absolute novelty requirement, make it easier for judges to increase the penalties for patent infringement, require disclosure of sources for genetic resources, and require inventions made in China to be first applied for in China unless a license is granted for a foreign filing.

Interestingly and although “junk patents” were a major target of the drafters of the amendments, it was decided not to insert a concept of patent abuse. It was felt that this concept should be dealt with under the provisions of the Anti-Monopoly Law. In other words there is to be no separate doctrine of patent abuse as there is in the U.S.

Secondly some are now suggesting that it is time to codify all the IP laws, as came into effect in Russia on January 1, 2008. Apparently however there are other priorities at this time such as the proposed new Tort Liability Law."

While on the subject of IP protection in China, it also bears mentioning that a Chinese court just handed down stiff prison sentences to a large and previously very successful software counterfeiting group. All of this reinforces what we have always been saying on this blog, which is that IP protection in China is and will continue to improve, but slowly, very slowly.

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When I was in high school, I went to a bakery in Budapest, Hungary, during the Communist era. The bakery was tiny, the kind that in the United States would have at most two people working there. I was the only customer. I ordered from one woman, was instructed to go to the cash register by another woman, had my pastry wrapped by another woman, handed to me by a fourth woman, and paid a fifth woman. Now that's what I call full employment.

China is not near to that yet, but foreign businesses would be wise not to underestimate how important it is to Chinese government functionaries that "their constituents have jobs. I thought about this last week when two of my firm's clients told me of their discussions with Chinese government people where the Chinese government people had stopped by to pretty much just make sure these two companies had no layoff plans. Both clients told me no threats of any kind were made, but both felt their standing with the government would be much better if nobody got laid off.

Today, the always excellent Managing the Dragon blog did a post aptly entitled, "Jobs: Now “Job One” in China," in which it talks about the heightened importance of jobs in China right now. The post goes on to set out the following "suggestions for foreign investors in China:"

-- If you are in a joint venture, now is not the time to be pressing for those labor-saving measures to increase its efficiency. In the best of times, Chinese partners and the local governments they answer to are sensitive to any job cuts that may threaten stability. In the current economic climate, expect the resistance to be even greater.

-- If you have a wholly-owned company in China, be careful in how you implement any layoffs. In the face of uncertain economic prospects, Western companies will instinctively seek to adjust employment levels, which is understandable. Even though your operation in China may be wholly-owned, however, this will not stop laid-off workers from taking their complaints to the local government–and the government will be listening. Talk to your friends in the local government ahead of time so there are no surprises.

-- Make the most of any expansion plans your business may have in China by publicly or privately announcing them. China has a long memory and remembers companies and individuals who come forth in difficult times.

I wholeheartedly concur.

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One of the great things about being a lawyer is that you get to work with and observe a diversity of businesses. My firm has helped all kinds of businesses get into China and do deals with Chinese companies and if I had to single out one industry that has the highest percentage of failures, I would pick those that are environmentally related. Years ago, I was totally gung-ho on these industries, figuring China obviously needs environmental assistance and Beijing knows it.

Not so fast.

Two things too often seem to get in the way. The first is that so much of this industry is tied to governments and this means so much of this industry is not as based on merit as it should be. The other thing is that this industry seems so "hot" that it brings in a disproportionate number of "flakes" and scammers. China is hot (or at least was hot) and greentech is hot (or at least is still sort of hot). Combine the two, and you have a recipe for bringing out those who do little more than move from hot industry to hot industry with little more than a briefcase and a claim that they "do deals." Find me a Westerner in China to avoid and there is a decent chance that person claims his or her business is "China GreenTech." There are plenty of completely honest and knowledgeable people in this industry, but it does attract its fair share of those seeking a quick and easy buck.

In an aptly named post, "Private investors, beware! China’s green sector still faces challenges," ResponsibleChina cites an article by Ray Cheung in the book, “Sustainable Investing: The Art of Long-term Performance,” setting out three obstacles GreenTech entrepreneurs face in China:

-- increased manufacturing costs, particularly of raw materials:
-- lack of human capital, since “the brightest minds are entering more lucrative industries, such as finance and information technology,” which can turn profits quickly, compared to environmental companies that require longer term development; and,
-- a fragmented market because of undeveloped regulatory infrastructure, i.e. lack of enforcement of environmental laws and weak environmental agencies:

All true.

GreenTech in China is and will continue to take off, but a sure thing it most certainly is not.

What do you think?

Hate to keep asking this, but if you like this blog (or even just mildly dislike it), please go here and vote for it. Thanks.

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"I won't pay. I know too much about extortion."
Tony Soprano, Season 3, Episode 7, "Second Opinion"

One of the "interesting" things about representing companies in emerging markets is the huge variance organized crime can play. The Associated Press, in a story entitled, "China readies for crackdown on organized crime," recently wrote on how the Chinese government is cracking down on organized crime

There is one country in which my firm does a substantial amount of business (if you go to the multi-language landing page of our website you can probably guess which one) where we ourselves were told that we would need to make monthly payments for our "own protection." Thanks to the intersession of a local friend, the party seeking to "protect us" realized we were not a proper party for the proposed "business" relationship. Our clients tell us the need to pay for "protection" is pretty common here.

None of our clients have ever told us of having to pay such money in China and I have never asked. I am asking now, though. Have any of you had to pay "protection" money in mainland China and, if so, in what city or cities? Do you have on good authority that others have had to make such payments? Were they domestic or foreign companies. My sense with China has always been that the government really does not want to see this with foreign companies and has made this fact sufficiently clear so as to generally prevent it. But we would love to hear from our readers on this.

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Most of you probably already know more about melamine than they ever expected. Melamine refers to both a chemical and to a resin produced from it. Human ingestion of melamine "may lead to reproductive damage, or bladder or kidney stones, which can lead to bladder cancer." Unfortunately, its high nitrogen content allows it to mimic protein and that characteristic has led to Chinese companies putting it into feedstock as an extremely cheap way of falsely boosting its protein content readings.

Here we go again, and this time it is hitting very close to home.

The Los Angeles Times just came out with a story, entitled, "Toxic melamine is suspected in seafood from China," on how melamine is being used in China to boost the protein content readings in feedstock being given to seafood. I say close to home on this for two reasons. One, probably around ten percent of my firm's clients are in the seafood industry or a related industry. One of my first big cases in China was seizing/arresting seafood in Dalian/Qingdao. Co-blogger Steve Dickinson lives in Qingdao these days and, in large part, that has to do with all of the Seattle seafood connections to that area.

Two, Seafood is a shockingly international business. A few years ago, my law firm was retained by the National Fisheries Institute (NFI) to represent (amicus curiae) foreign fish importers before the 9th Circuit Court of Appeals and the Supreme Court (certiorari was denied). I remember from that brief that more than 80% of the seafood in the United States is imported and I would bet that percent is even higher now. "By volume, China is the largest exporter of seafood to the U.S., and the second largest in terms of monetary value. In particular, China exports significant amounts of shrimp and catfish products, which represent two of the ten most consumed seafood products in the U.S." (April 25, 2008, Statement of the FDA's Don Kraemer, before the U.S.-China Economic and Security Review Commission Hearing on Chinese Seafood: Safety and Trade Issues).

The Los Angeles Times article starts out with the massive (and ever growing) numbers involved:

China is the world's largest producer of farm-raised seafood, exporting billions of dollars worth of shrimp, catfish, tilapia, salmon and other fish. The U.S. imported about $2 billion of seafood products from China in 2007, almost double the volume of four years earlier, according to the U.S. Department of Agriculture.

It then hits us with a critical string of bad news. Melamine is widely believed to go into feedstock for seafood in China, Melamine "can lead to urinary problems such as kidney stones and even renal failure," and, "unlike in cows and pigs, the edible flesh in fish that have been fed melamine contains residues of the nitrogen-rich substance."

The article then quotes a Burbank, California fish purchasing manager:

Brian Dedmon, purchasing manager for "China's a big place, and it does a lot of processing, and cheaply too," said Brian Dedmon, purchasing manager for the Fish King distribution plant in Burbank.

Fish King, which supplies hundreds of Southern California restaurants and has a store in Glendale, says it buys processed snow crab meat, squid and other seafood from China to meet market demand and because the price is competitive. Dedmon says the company relies on government inspections, its importers and its own experience to ensure the fish it buys is safe.

"We're definitely concerned about melamine, but by the time the fish gets to us, health issues should've been taken care of by the government agencies and brokers that we go through," he said.

I find this quote very interesting for many reasons. First off, about a year ago, when I was interviewed by various publications regarding Chinese food safety, I was asked if any of my food (many of them fish) importing clients would speak with the interviewer. Not a single one would. I particularly wanted one client to speak with the media to talk about how it was so conscious of food quality it had cameras recording every single food item that went into its boxes in China. Even this company would not talk, believing that no matter how much it touted its safety record and safety procedures, the only thing people would take away from the article was that it imported food from China.

I suspect Dedmon talked here because (at least as far as I know) snow crab meat and squid are not farm raised in China, rather, they are merely processed there. As such, those seafood items would almost certainly not pick up any melamine in China.

China Law Blog's own Steve Dickinson brings a bit of his own gloom and doom to the article:

In the U.S., commercial fish farms have to use feed from a handful of approved suppliers, but in China, there may be hundreds of thousands of sources for feed, said Steve Dickinson, an American attorney in China's coastal city of Qingdao who ran a salmon-farming business in Washington state.

Melamine has "infected the whole system in China," he said.

Even some Chinese feed suppliers are no longer denying the commonality of melamine spiking:

More than 15 feed suppliers in various parts of China were contacted for this story. Most of them declined to comment or said they didn't add melamine. But some of them said the practice of spiking feed with it had been going on for at least the last six years, with inspectors checking some types of feed products more tightly than others.

The US FDA is not yet testing for melamine in seafood and it seems most private testing outfits do not do so either.

For more on how to handle China quality issues (and in the spirit of "here we go again), check out the following posts we have done on this issue:

-- "China Products: Ya Want Quality? I Got Quality."

-- "China Quality Control: Darkness Before The Dawn."

-- "Quality Control Direct From The China Factory."

-- "China Products: Forget Trust, Just Verify."

-- "China Product Outsourcing Done Right: A Sort Of Guide."

-- "China Product Problems: What's Morality Got To Do With It?"

-- "China Products: Quality Costs Extra"

The biggest problem with melamine, however, is that it is so damn difficult to spot.

What should we do? I would particularly love to hear from people involved in the Chinese food business.

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Went to a party last night where a large group of us discussed the following scams:

1. Bernie Madoff.
2. Mark Dreier. I brought this one up and I have to give Dreir credit for managing to pull off a 300 million dollar scam, yet gain very little recognition for it because Madoff so quickly threw him off the front pages.
3. Lou Pearlman. I brought this one up also because the article on it in Vanity Fair does such a great job explaining it.
4. All of us lawyers then told about the scam cases on which we had worked or are working.

We then all concluded that blind greed had been a large factor in all of them. Obviously nothing revolutionary in that.

Stan Abrams over at China Hearsay (which is a blog you HAVE to put on your reader) did a post, entitled "In Defense of Due Diligence," tying Madoff in to China and pointing out how due diligence would probably have prevented the whole affair:

So what’s the point? There are a lot of crooks out there, and some of them are even pillars of the community. Why, oh why, would anyone ever do a deal without checking out the other party? Why do anything based on trust? I know the usual excuses, I’ve heard them for the past 10 years with respect to Sino-foreign deals:

1. Due diligence costs are too high.
2. We don’t have enough time to conduct proper due diligence.
3. People I trust vouch for this company.
4. The CEO is a close friend of . . .
5. The company has ties to the Ministry of . . .

You get the idea. None of this is new, and most people have read countless articles over the years on this topic. I am wondering whether the recent goings-on will make some people stop and think before doing something stupid. Perhaps, but I also know that the list of five excuses is compelling, even to the most professional deal-maker out there.

By the way, I shouldn’t keep this post limited to due diligence. All of this goes for other kinds of investigations and audits of licensees, distributors, suppliers, etc. Multinationals that don’t do their homework are asking for trouble, and with all the examples out there of bad practices, there really is no excuse anymore — if something goes wrong, you will be punished.

Stan is, of course, dead-on. I will add one more excuse to the list, one which I have heard twice in the last few months as an explanation for having already lost pot-loads of money: "We had never had any problems before."

For countless reasons, international deals are ripe for scams and I have worked on a ton of them. Virtually without exception, there were weird things that should have tipped people off as to what was going on, but these things were always ignored. Examples:

1. Why would there be an Atlantic Bank in Australia when it is not on the Atlantic?
2. Why would a company allegedly based in the Marshall Islands have misspelled the country's name as "Marshal Island" on its letterhead?
3. Why would an allegedly prominent London lawyer share office space with a Blimpies?
4. Why would an alleged US Federal Court case pull huge swaths of language straight out of Paul McCartney's divorce case. It took me a 1 minute internet search to discover this?
5. Why would a US lawyer call himself a barrister when the US does not have barristers?
6. Why would a large Moscow based company send all of its faxes from a mid-level hotel in Busan, Korea? Big surprise, it was not the Moscow company after all.

Be careful out there and have a MERRY CHRISTMAS.

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The weakened economy has served to highlight the renewed need to engage in best practices when securing product from China and Ashton Udall over at the Global Sourcing Blog has a nice post out on what companies need to be doing on this front in these tough times. The post is entitled, "Global Sourcing Outlook: Staying on Top in the Short Term." In it Udall makes "four suggestions for actions you can take now, to make sure your business does not get burned on the supply side, particularly if you have manufacturing sources offshore" in a "recessionary world economy."

Do a cost audit of your current supplier(s) and consider new suppliers. Prices negotiated 6 months ago may be uncompetitive now. Manufacturers are hungrier. Some, if not many, of their costs of production have dropped. Many of these cost reductions are driven by falling world demand (which we hope, and I believe, is a short-term phenomenon). Cost saving opportunities and their causes will vary from supplier to supplier, so reviewing price at your existing factories as well as looking at new sources, may yield an opportunity for short-term cost savings that could help your bottom line now. When demand picks up, it will be on your supplier(s) to raise the issue of rising costs with you. But, there is always a lag time between increasing costs and rising prices, so don't fail to capitalize on current conditions.

Monitor the financial health of your sources. Factories, both domestic and offshore, are facing very tough times and many are closing shop. Generally, when this is happening, their isn't much incentive for factory owners/managers to let their customers know, "hey, we may not be around in a few months". While "credit checks" in low-cost country sources (LCCS) are generally not typical of what we might consider a credit check in the U.S. (i.e. running a credit check through Dunn & Bradstreet), informational audits that can be performed through 3rd party information gathering can aid your assessment of your supplier(s) financial health and risk. There are companies that perform these services in popular LCCS' like China, India, Mexico, etc., and you can generally get an idea of a factory's current credit situation and perhaps some current financial information. This could give you the heads up you need to start securing second and third sources of supply, in case your primary source suddenly stops responding to your emails and phone calls, and their website disappears. Performing these kinds of audits are not too expensive, $US500 to a few thousand dollars, and may save you your business in the long run.

Continue monitoring your quality control, and if you haven't been doing so very well thus far, START NOW! Don't become a quality disaster/recall headline or a product liability defendant. When times get tough, suppliers look for ways to lower costs and maintain margins. Many may feel inclined to let the quality of materials or workmanship slip to save a few cents on your next order. If there is ever a time to continue your quality control program or implement a quality control program, it is when companies supporting you are potentially hurting.

Don't treat your suppliers as the enemy. An honest conversation may open up new opportunities for mutual gain. When times get tough, people often begin looking for easy scapegoats and targets. It may be tempting to push unreasonable demands and threaten even your best suppliers. None of the recommendations above are intended as a suggestion to get absurdly tough on the vendors supporting you. Be diligent, negotiate well, and expect results. Approach the need for businesses to survive during these challenging times from the perspective of "how can we work together to mutually survive and eventually flourish?" Gaining transparency in the supply chain ("transparency"-- basically sharing information) is a best practice in good and bad economic conditions. Being forthright and reasonable with your suppliers will not only earn you their respect and appreciation, but may open opportunities for new ways to reduce costs, improve efficiency and/or quality, and present new business opportunities. This is such an easy, but often overlooked method of dealing with supply chain challenges, and it might begin with a simple and honest conversation.

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Jack Perkowski, who knows as much about China business as anyone, recently wrote a piece for the Far Eastern Economic Review, entitled, "The Return of China Heavy." By China Heavy, Perkowski is referring to what some call the "real China," the China beyond the Westernized portions of places like Shanghai and Beijing. The economic downturn is hastening this return:

After experiencing “China Light,” it’s difficult to imagine that “China Heavy,” the darker, less economically and legally developed side of the country, still exists. However, a slowing economy and a dramatic decline in asset prices are demonstrating that China Heavy is alive and well, and investors should beware. Like rocks in a river that only become visible when the water-level drops, signs of China Heavy are now coming to the surface as the country’s economic waters recede. Recent articles on troubled investments in China, by foreign and domestic investors alike, are once again highlighting corporate governance and other legal issues that were the subjects of the China stories of the 1990s.

I completely agree as over the last three months or so, my law firm has been going crazy with what Perkowski would call "China Heavy" work. Six months ago, 99% of our work involved helping Western companies get into China and do deals in China; now, about half our work involves helping Western companies extricate themselves from joint ventures and other deals gone bad and to help them collect on unpaid debts. Since the inception of this blog, we have been warning of days like these and now that they are here, all we can do is reiterate the things Western companies must do (these things have become even more critical) to reduce their risk of problems.

Perkowski does a fine job setting out the basic things of which Western companies must be vigilant:

What should investors pay particular attention to in today’s tougher economic environment? Following are a few due diligence items that warrant enhanced scrutiny:

Accounts Receivable have always been problematic. Despite the substantial progress made by Chinese banks, the country still does not have an efficient system for distributing capital. When times are good and property and stock prices are rising, bank loans secured by real estate or shares are plentiful. When the markets turn, the banks are quick to demand repayment. As a result, customers that looked financially secure a year ago may now be problem accounts.

Understanding the true profitability of a company in China is often more art than science. Rapid asset inflation has made it even more difficult. For example, historical profits of many Chinese companies have been bolstered by stock-market gains. Like individuals, companies in China flocked to a rising stock market and made money on the way up. Those profits cannot be counted on in the future, and there may even be hidden, unrecognized losses on the balance sheet.

Recent sharp declines in raw material prices mean that inventories may well be vastly overstated. In a post 2005 world when raw-material prices seemed to rise ever higher on a monthly basis, the temptation to overbuy at current prices has been strong. Also, some companies have sought to lock in prices of raw materials by entering into futures contracts with suppliers. Prior to the economic crisis, that seemed like a safe bet. Today, it can represent a large off-balance-sheet liability and an overhang on future earnings.

Off-balance-sheet liabilities are especially difficult to find and quantify in China. A recent example: the shareholders of a company made certain promises to its workers which they chose not to disclose to the new owner, a prominent Chinese businessman, when they sold him the company several years ago. As the factory’s fortunes turned down this year, the workers demanded payment and took the new owner hostage when he refused to pay.

Getting proper title to land use rights is challenging in China. Furthermore, in a fast growing market where getting into production as quickly as possible is the prime concern, it is often put off until later. Rapidly escalating property prices have presented an ideal opportunity to sell off or pledge real-estate assets as a way to get cash. In the current environment, investors would be wise to clarify title early in the process to determine both true ownership and the nature of any outstanding claims.

All true, and all this can be summed up with the old adage of due diligence, due diligence, due diligence.

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Not exactly sexy, but absolutely crucial for anyone sourcing product from China are the nuts and bolts of how to do so. I have been around long enough to see the countless mistakes sourcing neophytes can make when buying product overseas, including the following:

1. Not realizing that the payment was for product at the factory, and did not include any transportation costs.

2. Not realizing that the Christmas product ordered in August would not arrive until the following year.

3. And my personal favorite, and one I have seen on more than one occasion, not realizing until the product hit the United States that it is illegal to import or has a prohibitive duty.

Anyway, the über practical China Sourcing Blog just did part 4 of its series entitled, "How to Make a Good Enquiry" and those at all new to buying goods from China (or from anywhere else, for that matter) would be well advised to check them out, here, here, here, and here (in order from 1 to 4).

The concluding sentence of the last post in the series is as follows:

In this series we have talked about a lot of elements which together make a good enquiry. These elements can reduce risk, increase sellers' and therefore buyers' efficiency, and of course help in getting the quotation you want.

I wholeheartedly agree.

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One of the things I love about being an international lawyer is using outside events to interpret the law. Now I know this is going to anger a lot of people, but non-lawyers generally do a terrible job interpreting the law. This is true worldwide. Examples of this abound:

Non-lawyers tend to look for "the law" that applies to their situation. Once they have found that law, they think they are done. What they so often fail to do is put the law into context. Many years ago, we had a fairly client [I am going to get intentionally vague here] who was doing a big project in a foreign country. The client had read that companies in this country for less than six months did not need to pay a particular tax and they did not pay this particular tax. They had failed to read that this law (and a whole slew of other laws) did not applly to companies employing more than 50 people and this failure ended up costing them hundreds of thousands of dollars in penalties and attorneys' fees.

Non-lawyers often fail to realize there can be many different laws applicable to the same factual situation. The easiest example is that there can be national laws, provincial laws, and even city laws (this is particularly true with respect to China's employment laws) and merely following one set of laws can leave you very much exposed.

Non-lawyers tend to believe all laws mean what they say, even though this is oftentimes not true. Laws sometimes neither mean what they say nor are they always enforced. Sometimes there are laws that say one thing, but some other law or case or bureaucrat says another, and that other essentially becomes the law.

Lack of enforcement can be a huge issue in China. There are all sorts of laws in China that are on the books, yet only sometimes enforced, only enforced in some provinces and cities, or only enforced against some companies. As I have often written, a Chinese company getting away with not following a law should mean very little for a foreign company.

I am certainly not saying anything new here and everything above is known by most lawyers and has been said on this blog many times before. But I am writing about it now because I am getting the strong sense that there has recently been yet another tightening up of enforcement in China against foreigners and I attribute it directly to the economic downturn. China, like so many other countries experiencing an economic downturn, is fighting even harder for its own people at the expense of outsiders. If the Chinese themselves are going to have trouble making money, the Chinese authorities are going to need to step it making sure foreign companies are not taking away economic opportunities from its own citizens. We can argue all we like about whether this is good economics, but I do not think it can be disputed that it is good politics.

This all came into stark relief for me in the last few months when something happened twice that has never happened even once before. Two companies called us about "cleaning up" their legal acts in China. These two companies were doing well in China, off the grid, and they retained us to get on the grid. By on the grid, I mean, registered as foreign companies with written contracts with their employees, and an employee manual. Both of these companies were located in tier two cities and both had been doing business in those cities for a couple of years. They retained my firm, paid the retainer, and we started doing the work. But, in both cases, well before we had even gathered up all necessary information, these two companies had been shut down and told not to even bother.

Over the last few years, we have registered countless companies in China that had been operating quite openly without registration for years. We registered one company that purchased more than $300 million in Chinese goods a year and employed more than 3000 people. We registered another company that had been operating for more than 15 years. But only after the economic crisis has begun have we ever been in the process of bringing a company within the law only to have that company thrown out. I cannot say more at this point because these two companies are both looking into their various options, but I can say that from our perspective, it seems China is going after foreign companies as fervently as I have ever seen and I have no doubt economics is the reason.

For more on this stepped up enforcement against foreign companies, check out the following:

-- "China Deters Foreigners From Selling Bank Stakes," at China Bystander.

-- "The New Chinese Economy & You," at ChinaSolved. This post starts out with the following:

The Chinese economy is already starting to look a little more protectionist and inward-looking. If you need proof, take a look at Sunday’s FT article that quotes a directive from China’s Civil Aviation Administration,

‘It also exhorted domestic airlines to unite and develop together “to form a ‘fist’ in the face of international competition” while avoiding competition with each other domestically.’

It concludes by very wisely warning of what it calls "legal gray areas":

Legal gray areas – Are you in a legal business, or a ‘not illegal business’? ‘Not illegal businesses’ are great for bull markets when they help facilitate the flow of funds sloshing around. Unfortunately, they quickly turn into ‘not approved businesses’ when things get leaner. Think hard about your basic business model and make sure it’s bureaucratically bulletproof. In China, bureaucrats are the shock troops of a trade war. They live for this moment.

Will Chinese bureaucrats really be the "shock troops of a trade war" or are we just being alarmist?

UPDATE: The Off the Record Blog has a great post, entitled, "Could Coke lose its China fizz over student allegations?" on very recent (and very heavy) China buzz relating to allegations (and that is all they are at this point) of Coca Cola's having violated China's Labor Laws. Is this a sign of what I am talking about above, or just an isolated incident?

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The United States has hit China with a WTO case, contending China has been subsidizing its exporters, particularly its largest and best known companies. The US government is alleging that China's central government, provinces and cities have all been paying subsidizing many Chinese companies that export.

As my kids would say, well duh!.

Since this has been going on since forever and since everyone knows it, the real question is why has the US brought this lawsuit now? I do not know. In fact, if anything, the timing seems very strange. First off, it would have been good politics to have brought it before the recent elections, but that was not done. Second, if the US wins and China has to stop subsidizing its exporters (or push those subsidies a bit further underground), this will mean higher prices for buyers in the US and elsewhere. Of course, these higher prices will also been US companies will be better able to compete with Chinese companies on the world market and that, no doubt is why this case has been brought.

Click here for the Office of the United States Trade Representatives "Fact Sheet" on this lawsuit [h/t to Laurel Delany of The Global Small Business Blog, who alerted me by email to this filing]

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In a post entitled, "Why China Matters, Part 2," Steve Ganster explains why Western businesses should and do continue to look to China for growth and for manufacturing. Yes, China's growth is slowing considerably, but at least we are still using the word, "growth."

Ganster does a great job laying out what China still offers:

-- A strong and deepening supply chain and infrastructure
-- A major and continually growing domestic market in addition to export potential
-- Large volume scale and its benefits to cost competitiveness
-- An ample workforce that can be trained and empowered
-- Significant latent productivity to be gained by further process improvements
-- A very supportive pro-business government

Then, in what for me is clearly the money quote of the post, Ganster says, "Talk to Westerners who have dealt with government, employees and unions in Vietnam, India or other developing southeast Asian nations. This may open your eyes to the positive things China offers."

So true. So true.

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I am a big fan of Thomas Barnett who is, perhaps, most famous for dividing countries between core and gap, as explained here by Wikipedia:

Barnett has termed the globalized countries the "Functioning Core," or simply "the Core." The other countries are part of the "Non-Integrating Gap," or simply "the Gap." The Gap has been shrinking as globalization has expanded. Since most terrorists seem to come from the Gap, he believes that the American military should focus on building partnerships with "seam states," countries bordering the Gap, to stabilize those regions. Stable states would bring more investment and more connectedness with the outside world, therefore progressively shrinking the Gap. The end result of all of this, if it proves to be successful, would be nothing less than the end of interstate warfare on the planet, and probably a significant reduction in intrastate warfare and other problems like terrorism.

I was reminded of these distinctions when I read this post on China Bystander, entitled, "China Considering Sending Warships To Fight Somali Pirates." Many years ago (while under a mosquito net in Papua New Guinea, but I digress), I read Bernard Lewis's book on Islam, entitled, "What Went Wrong," and he too seemed to divide the world between those countries that have embraced modernity and those countries (almost exclusively Islamic) that have explicitly rejected it. I divide the world between those countries that are already integrated into the worldwide economy or moving towards such integration and those countries (Iran, Zimbabwe, North Korea, quickly come to mind) that seem too distracted by internal and/or external repression even to try moving forward economically or to engage or work with the rest of the world.

Yes, China's talking of sending troops to Somalia is out of self interest, but it does show engagement and it does place China squarely within the core.

UPDATE: Barnett says the same thing, a day later, here.

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Apologies to Jack Nicholson.

Having grown up in a small Midwestern city, I have an inherent (and what I see as a healthy) distrust of government. Every government. Anywhere.

I was yet again reminded why when I read this excellent Wall Street Journal article on British Petroleum's recent problems in Russia, entitled, "Misreading the Kremlin Costs BP Control in Russia Venture." BP thought its getting close with key Kremlin players would protect them in Russia. Most unfortunately, for BP, however, when its key Kremlin players fell out of favor, it too fell out of favor. Russia can be particularly problematic, but other countries certainly are not immune. I have seen up close and personal how allying with government can be like playing with fire:

1. Many years ago, I was working with an American company who was on the verge of getting a huge supply contract with the Korean navy. The son of the President was setting up the deal. I knew the deal was in the trash when I saw the son on the US evening news getting into a Korean police car in handcuffs.

2. Many years ago, my law firm had a very close relationship with a Russian vice-governor. His beloved daughter was one of our paralegals and, lo and behold, company after company from this Russian province would contact my firm for international law assistance. This work dried up rather quickly when the father was axed to death.

3. Many years ago, we had a client who ran a business on Chinese military bases. The whole practice was of questionable legality, but his closeness to a high ranking military official seemed to isolate the enterprise. Then the high ranking official retired and within less than a year, our client was off all the bases and a new company was there in its place.

4. We had a Russian company as a very good client, the owner of which decided he wanted to be Governor of his province. He ran and lost, in a fairly close election. Within a year, his various companies had become greatly diminished because of constant government investigations, that appeared to have been done to keep our guy in his place and to teach him not to run for office again.

Government people come and go and when your people are gone, much or all that you have worked for goes with them. This is NOT a reason not to ally your company with government, but it sure is a reason to remain wary.

Would love to hear your China stories on this, as I am sure there are many out there.

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There is a fairly prevalent theory that the best time to start a new business is during a recession/depression. I buy that. During tough times, established companies often disappear, get overly cautious, and lay off scads of good people, who can be hired relatively cheaply. During tough times, big shifts can occur. A few months ago, I pretty much scoffed at the idea of Shanghai becoming a financial capital, in a post, entitled, "Shanghai To Replace New York As World's Financial Center. I Don't Think So." Though I certainly am not convinced, I certainly am not scoffing either. To use a bad pun (particularly during this bear market), China is grabbing the bull by the horns and seems to be boldly making moves to increase its worldwide standing as a financial center.

My best friend from college, attorney-editor-author, Jacob Margolies (b/k/a "THE Cob") was kind enough to send me the notes from his interview of some of the people who came from Shanghai to help lead a group of Chinese financial companies who had traveled to London, Chicago, and New York in search of bi-lingual Chinese-English financial talent (strongly focusing on Chinese nationals).

Jacob's notes are as follows:

By the way, no US press attended this event only Chinese and Japanese
(maybe 6 reporters in all)

Shanghai Job Fair Press conference-December 13 at Sheraton LaGuardia
East hotel in Flushing Queens
------------------------------------------------
Dali Mao, deputy director General -- Shanghai Bureau of Human resources
and Social Security:

(He introduces the delegation members and welcomes everyone and thanks them for coming to learn more about Shanghai)

We started our trip on December 5. Our first destination was London.
On December 6 we held a similar event to this in London and on
December 9 we held another one in Chicago and this today is the last
event of our trip. We have two main objectives for this trip. The
first is to welcome potential candidates to come to Shanghai since the
city is trying to build itself into an international center of
economy, finance, trade and shipping center in the world. The second
purpose is to take this opportunity to meet with Chinese students and
those Chinese who have been working abroad and learn about their
current situation. This is part of our regular work. That is a brief
introduction.

Q-and-A

Q: According to one report, 27 companies from Shanghai are
participating in this event. Can I ask how many people are you going
to employ and how is the reaction of the applicants?

A: Actually 19 financial institutions from Shanghai came with us on
this trip and another 10 financial institutions of Shanghai put up
their vacancies for them. They did not actually come on the trip. We
have 170 mid-level to high level job vacancies that we brought over in
the financial area. And we also brought over job information on about
1,000 non-financial job vacancies.

Among those 170 positions, it covers jobs in banking, insurance, asset
management and pension insurance.

This event has received very positive feedback from the Chinese
overseas applicants and also from the media.

Nearly 1000 turned out to the event in London. 200 turned out in
Chicago. And according to our very initial calculation already 400
have registered for today's event. (note it seems over 1000 attended
in NY judging from the large crowds)

This is the biggest event ever organized by the Shanghai municipality
in terms of financial human resources (HR) exchange to set up a
platform for companies to participate in international HR exchange.

Q: (from Taiwan media) Was the trip planned before or after the
financial crisis? And what has been the response of laid-off
financial people abroad to this event?

A: This event is part of our regular work. Shanghai has set a
development goal to be an international center for economics, finance,
trade and shipping in the world. This has been, our so called
4-center strategy, since 1992. In order to build an international
city, you need talent from all over the world. We need financial
talent from all over the world. So this event just happened
coincidentally with the financial crisis. We did similar things
before. We had a similar event in 2002 and earlier.

So far we have received very positive response from the applicants
whether or not they had been laid-off. Generally they want to learn
about the situation in Shanghai. Rather than just a job fair, it is a
kind of information exchange event for those who want to have career
development in China and Shanghai.
---------------------------------------
Sheng Yu Rao-Deputy Director (Division of Human Resources)

Before our departure from Shanghai, we did a lot of preparation to
ensure a proper result We did not just put out job information but
also worked to enhance overseas Chinese knowledge about Shanghai
and also upgrade the local institutions and help them to have better
knowledge of the needs of overseas Chinese professionals. We have
strengthened contacts and channels with overseas Chinese
professionals.

Our initial results have been very positive not just from the people
who showed up but also from the overseas financial institutions who
told us they appreciate us for organizing this event. This has
deepened knowledge about Shanghai. There was a lot of detailed
preparation work to make it easy for the applicants to find a match.
We brought over 12,800 documents, not only about the job openings but
also about the financial institutions of Shanghai and also about
recent developments of Shanghai's financial industry. And we have
provided contact details for these institutions so overseas Chinese
can have further contact with these institutions. This is a good
opportunity to open and broaden mutual exchange channels with overseas
Chinese.

By way of comparison, we did this in 2002 and then brought 7 companies
and had 50 job openings for the financial service bureau. So you can
see that the scale is quite different this time. It is a big
difference today. Just in terms of quantity it is much higher than
2002.

---------------------
Weimao Huang-Director General Secretary (Station chief) Shanghai
Municipal Bureau of Human Resources and Social Security:

The issue of returnees, Chinese students studying abroad, is an issue
that the Shanghai municipality attaches great importance to.
Currently we have over 70,000 returnees in Shanghai. We have been
doing our best to attract Chinese students overseas back. Since 2003
we started the so-called 10,000 convergence program-aiming to attract
10,000 students back in 3 years time. And so far annually there have
been about 5000 Chinese students from overseas returning to China and
they have done a great job in adding to the local economic and social
development.

Almost every year we organize some kind of event to enhance contact
with overseas Chinese professionals. In short, we expect more overseas
Chinese to come back to Shanghai to support the economic and social
development and we will provide them opportunities to realize their
career ambitions.

[Mr. Huang invites you all to Shanghai to learn about this overseas
Chinese and career development.]

Q: Has the financial crisis in NY or London affected this trip? Have
businesses in Shanghai decided not to hire that previously had been
planning on participating in this event?

Mao: The China market is pretty normal still and development remains
the key theme and that includes developing a financial center in
Shanghai. So in terms of this event, we do not see any negative impact
at all in terms of the recruiting side.

Q: How are pay and benefits compared to US and Europe in financial
services industry?

Mao It varies depending on the institution.

Q: Can you hire laid-off Wall Street workers at a lower cost now?

Huang: We will not reduce our pace or speed because of the financial
crisis in building a financial center in Shanghai. We still have
dozens of companies coming here to recruit which reflects that the
financial industry in Shanghai is still in quite good shape.

We are very serious about this event and you can see we put out very
detailed job descriptions in terms of job titles the institutions have
listed jobs in development strategy, asset management, working with
financial derivatives, and also for IT jobs.

In terms of salary, we have jobs hiring for up to 1.5 million rmb
which I think is roughly $220,000 dollars.

What do you think?

PS Sorry to keep hawking for votes, but I am pleased to say we have taken the lead in the American Bar Association's (ABA) Best Law Blogs competition and I would certainly appreciate your going here and voting China Law Blog.

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I rarely have revelations, but after being knocked over the head countless times over the years, I finally got one regarding how Chinese businesspeople view their businesses differently from how American businesspeople view theirs.

The other day, a deal my law firm had been working on for a US company fell through, much to the consternation of nearly everyone involved. By everyone, I mean the lawyers, the accountants, and the US company. The only party that did not want the deal to go forward was the Chinese company. I am going to have to be incredibly vague here, for attorney-client and confidentiality reasons, but the main reason the deal fell through was because the Chinese company (the Chinese company is really an American-Chinese company run by a Chinese family) did not like how the American company had so little cash on hand. The Chinese company kept insisting that it did not want to give up its cash position, even though everyone else kept insisting that cash had nothing to do with the deal and that cash on hand could be equalized.

At around that same time, both Steve and I were communicating with two different Chinese companies that were owed considerable sums by US companies and both were unwilling to spend any money at all in an effort to collect those sums. Steve and I could not understand why they were unwilling to risk relatively small amounts to fund litigation to recover relatively big amounts, particularly since in both instances we believed that if these two companies did not get more aggressive in their debt collections, they would end up going under. For more on this phenomenon, check out this post, entitled, "Ranking Creditors. China Comes In Dead Last."

Then it struck me. The typical Chinese businessperson is far more protective of his or her cash and far less protective of his or her business than an American businessperson. American businesspeople frequently put in their cash into their businesses to keep it going, whereas Chinese businesspeople seem not to. I suspect the following reasons for this, but would LOVE to hear other potential reasons from you, our dear readers:

1. Americans are always talking about building a business. Businesses are run for more than just money. They are run as something to pass on to one's children. They are run for the employees. Not saying money is not also a huge factor, but the sense I get is that it is less of a factor for an American business than for a Chinese one.

2. Americans put their lives into their businesses. Many Chinese do also, but many also are there due in large measure to their government connections and to government largess. I suspect this too plays a part.

3. Americans do not generally fear the government will shut down their business. This is less true in China.

4. Americans generally know that if they put their own money into their business and their business collapses, they themselves can declare personal bankruptcy and start their personal financial life over again. This encourages them to borrow, borrow, borrow to save their own businesses (or at least it did when borrowing was so easy). Chinese individuals have not had such ready access to credit nor is failing to pay one's personal debts in China treated remotely like it is in an American bankruptcy.

These are the reasons why I believe Chinese businesspeople tend to emphasize cash much more than American businesspeople and why American businesspeople tend to emphasize saving and growing their business more than Chinese businesspeople.

Again, what do you think? Am I off base here? If I am right, then how does this affect how one should deal with a Chinese company?

PS I am slowly but surely gaining on the first place position in the ABA Journal law blog election and I would very much appreciate your voting for China Law Blog here. With you, it's "Yes We Can."

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