Julie Williamson recently interviewed Thomas Yih about the legal issues executives will face when planning a market entry into China. Thomas is a goldmine of information from his extensive, practical experience of guiding US companies through the process.
Thomas Yih is currently Associate General Counsel at Sun Microsystems responsible for legal support for all lease and finance transactions in Asia Pacific.
Top 10 Legal Essentials
1. Business Plan
Start with a comprehensive business plan and get everyone on the same page. It’s a team effort that will involve your best advisors on tax, finance, risk management, treasury and legal issues.
Make sure your plan is thorough and considers all key aspects involved in entering a foreign market. That includes taxes, capital investment, government / regulatory approvals, repatriation of funds, and licensing requirements.
Once you have a plan, seek input from local advisors, either a law or accounting firm. Use someone who is on the ground, with ‘been there - done that’ experience. Such experts can be tremendously helpful to provide you with a smooth start. A good local advisor will have established and lawful relationships with key government officials. And in China, such relationships can be critical.
2. Entity Structure
Determine what entity structure best supports your plan. Will you be using a representative office that provides marketing assistance? Perhaps you need to make a larger commitment in which case a local subsidiary could be a better choice. The typical ‘wholly owned foreign subsidiary’ in China is referred to as a WFOE (referred to as a “woofie”).
Other choices are teaming with a local partner, a local distributor, or on a more significant scale, a strategic alliance or joint venture partner. In any scenario, a thorough due diligence of your potential partner is essential. Set appropriate expectations. Retaining a local partner takes time, energy, and money.
3. Tax Obligations
Tax obligations should be one of the first considerations. I highly recommend retaining experienced, international tax advisors. They will help you find the answers to questions such as:
- What taxes will you incur when selling goods or services?
- Will value added tax apply (“VAT”)?
- How can you lawfully avoid creating a permanent establishment?
- Can you leverage reciprocal tax treaties between the US and China?
- What would subject a person to personal income tax obligations?
In the past, tax holidays were often available to new foreign businesses depending on the foreign investment value and perceived value of the technology or services to be provided.
Recently though, with the significant influx of foreign investment, China’s lure to foreign business entities has lessened and tax holiday offerings diminished. However, it is always prudent to inquire about tax holidays and other investment incentives.
4. Business License and Registration
Research the registration requirements and business license approval process. Will your investment and activities require approval from the local, provincial or central Beijing government?
Determining the right government authority for approval typically depends on the amount of your foreign inward investment and the products or services you will provide. Lower investment amounts may only require provincial approval. Amounts over US$30 million will require central government (Beijing) approval from the China Ministry of Foreign Trade and Economic Affairs (MOFTEC).
Law and accounting firms can be a tremendous resource to assist you in obtaining the necessary approvals in a timely manner. Retaining a local advisor who has "lawful" relationships with government officials will be money well spent. Such relationships can have a tremendous effect in expediting your application and channeling your registration documents to the proper hands.
I emphasize “lawful” relationships as China is identified as a country prone to corruption. Educate yourself and be mindful of the U.S. anti-bribery, books and records laws that apply to transactions in China.
According to the United States Foreign Corrupt Practices Act (“FCPA”), generally stated, it is unlawful to provide any government official with anything of value to obtain or maintain business, or gain an unfair advantage. The FCPA can easily become complicated, so using legal counsel to thoroughly understand the FCPA is highly advised.
It always takes more time to get registration approvals than you initially anticipate. Be sure to establish appropriate expectations with your team.
5. IP Protection
Intellectual property protection and, particularly, enforcement of intellectual property rights in China remain questionable. While a condition of China’s entry into the WTO was to improve and heighten intellectual property rights and enforcement, implementation has been slow.
Therefore, I highly recommend that you retain a local, experienced, legal advisor who can provide the best measures to protect your company’s intellectual property to the extent it can be protected and, if necessary, enforce your company’s intellectual property rights.
6. Non-Disclosure / Confidentiality Agreements
Prior to any discussions with a potential distributor, partner, service provider, or advisor. Make sure that you have a signed, nondisclosure/confidentiality agreement in place between both parties!
7. Employment Laws
Familiarize yourself with the employment laws that will apply to your business. Employment laws and their enforcement vary throughout the provinces in China. You’ll need to know the answers to questions such as:
- Will your business hire local employees?
- Are the employees members of a union?
- What benefits are the employees entitled to (e.g. housing)?
- Do the employees have termination rights?
- What are the Visa requirements to or from China?
8. Money Flows
Learn all about money flows, currency exchange controls, and repatriation of funds. Let’s assume your business will do well and make a profit. Will you be able to get your money out of China? Make sure you review and understand the repatriation process. What are the requirements and restrictions in opening a local commercial bank account?
9. Due Diligence
Conduct thorough due diligence on all potential partners. Inquire about the ownership of the proposed partner. Find out if it is a state-owned company, which is common in China. If so, that provides a whole host of other considerations - specifically, adherence to the FCPA as identified above.
Performing due diligence on your proposed partner is critical. What assets do they own? What is their specific financial condition? Does the proposed partner adhere to and practice generally accepted accounting principals (U.S. GAAP). Who is their Board, executive, and management team comprised of? Are any of these members Party officials?
10. Exit Strategy
Your business plan should contain a clear exit strategy in the event that you need to wrap up operations in China.
Does your exit strategy clarify how to dissolve/de-register your entity, terminate third-party/partnership agreements, relieve employees, sell or assign capital equipment, terminate office and/or warehouse leases early, and repatriate all remaining funds?
Maintain your relationships (referred to as “Guanxi” in China) as best as you can. “Saving face” in China is very, very important. Leave the door open to come back.
FINAL THOUGHTS
Obtain legal counsel experienced in China transactions and law. Legal counsel should draft the contract and assist in negotiations. Particular areas of importance include governing law, the use of Arbitration (CIETAC or ICC), limitation of liability, indemnification, force majeure, and the English language governing and controlling the interpretation of contract terms.
COMMERCIAL TIPS
Make sure you have a member of your management team on the ground in China overseeing your local operation. Attempting to manage from afar is a recipe for failure. You need someone from your management team on the ground at all times.
Advise your executive team and your board of directors of the potential risk of losing your foreign investment in China. Yes, the China market is growing at a rapid pace. China, however, remains a communist country and things can change in an instant.
My advice has always been to only invest in China if you can lose your entire investment. And, despite such loss, be able to continue operating your domestic business without interruption. In other words, “do not put all your eggs in one basket.”
RESOURCE TIP
Use the US Commercial Service. It is a great resource for any business person seeking or exploring the idea of doing business in China.
DISCLAIMER
Because of the generality of this conversation, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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