StartUp Tools: Business in China

One of the most common calls my law firm receives is the one from someone saying that they want to "start a business in China." The first thing we do with that sort of caller is to seek to ascertain whether a China business is actually necessary. Forming and then operating a business entity in China is not fast, is not easy, and is not cheap. I usually convey this by asking the caller if they find it easy running a business in the United States (or Europe), what with having to figure out and pay taxes, rent, wages, vendors, etc. I then point out that having a business in China means they will have to do the same thing over there. So whenever possible, we seek to determine whether there is some way the caller can conduct business with China, achieve its goals with respect to what it is seeking to do with China, while not having a business in China at all. For potential alternatives to forming a China business, check out the following:

But if forming a China business does make sense, the next issue is what kind of business makes sense. On this, you typically have three choices: a Wholly Foreign Owned Entity (WFOE), a Joint Venture (JV), or a Representative Office. These days, the overwhelming majority of foreign companies seeking to do business in China go in as a WFOE, but there are definitely still instances when a Joint Venture or a Representative Office makes sense. For more on the differences between these three sorts of entities and on what it takes to form each of them, check out the following:

If you are going to have a China business entity, you are going to have employees (indirectly in the case of a Rep Office). That means you are going to need written employee contracts (it virtually always makes sense to have these in both Chinese and in English) and a written employee manual/employee handbook (again, in English and in Chinese). You probably will want your employee agreements to speak to issues like trade secrets and non-competes (which are limited in China) and overtime. For more on employee contracts and employee handbooks, check out the following:

The last thing you need to focus on if you are going to be doing business with China, particularly if you are going to be doing business in China, is protecting your intellectual property. In nine out of ten cases, this means registering your trade name and your other important trademarks in China. On some occasions, this also means registering your patents or copyrights in China as well. For more on registering your trademarks in China and protecting your IP there, check out the following:

The above are the four main issues confronting foreign companies seeking to do business in China. 1) Determine if a China company is necessary. 2) If a China entity is necessary, form the right one. 3) If you are going to have a Chinese company, you should have the proper employment contracts and employee manual. 4) If you are going to be doing business in China, you are going to need to take certain steps to protect your IP.

That was easy, wasn't it?

Disclaimer: This document contains links to Web sites not under the control of the Government of Canada.

Introduction

China's culture and business practices differ from Canada's. As you start or expand your business in China, having an understanding of Chinese business etiquette is important to your success. Knowing and practicing common customs will also help you relax, avoid embarrassment, and focus on the matters at hand on critical occasions. This document provides a brief set of guidelines on Chinese business customs and practices based on queries that have been received by Trade Commissioners at our Embassy and Consulates in Greater China. For further information, there are reference links at the end of the document. While nothing can beat your own personal experience, we hope that this information will be of assistance in sensitively guiding your activities.

In your business dealings in China, you will make many friends, both Chinese and foreign, who can help you learn the ropes. Follow their advice and example! The toughest business people you encounter will often also prove to be genuinely warm and accommodating hosts, and will overlook simple errors of table manners or business etiquette - as we would in Canada - if your purposes are serious and your conduct respectful.

Background

Before beginning, recognize that the following qualities are valued by the Chinese and therefore relevant to your Chinese business interactions today:

• Saving and giving face
• Respect for elders and rankings (note that the latter is particularly important when dealing with government officials)
• Patience
• Politeness
• Modesty

Approaching Business in China

Doing research on the market is important in China, but personal relationships are equally essential to business success here. It is crucial to establish and maintain good relationships with key business contacts and relevant government officials. Attending industry networking events, contacting industry associations and municipal or provincial investment promotion bodies, and following up on personal introductions are all good ways to start the relationship-building process.

While many Canadian firms have done business successfully with credible firms in China, it is important to remain aware of potential scams that you may encounter as you approach business in China.

For further information on scams that can affect your business, please see our report on the Trade Commissioner Service website regarding frauds and scams.

Attending and Conducting Meetings

In general, meetings in China follow the same format as those in Canada, albeit with a bit more ritual. The Chinese value punctuality, so arrive on time or even slightly early for meetings or other occasions. The following points should be kept in mind:

• Dates: Check the Chinese calendar. If you are scheduling a meeting, avoid all national holidays, especially Chinese New Year, when the entire country effectively shuts down and it can be very difficult to organize meetings with key individuals. The May 1 and October 1 holidays also affect businesses: be forewarned.
• Preparation: Be well prepared in advance of your meetings.Your Chinese hosts will most likely know you and your business quite well. Have a detailed proposition of the value of your company and product; your counterparts will have one for you (see section below on "Materials"). Chinese businesses often meet with numerous foreign businesses seeking to establish relationships; if you are unable to capture their attention at the first meeting, you may not be able to secure follow-up.
• Language of the meeting: Make sure you know the language capabilities of your hosts before the meeting. It is more convenient and reliable for you to have your own interpretation if your hosts don't speak English or have little English capability.
• Meeting room set-up: If you have specific requirements for a meeting room set-up (e.g. projector and screen), be sure to communicate this to your hosts in advance of the meeting. They are usually happy to accommodate, but often do not have the in-house capacity to set up the technology on the spot.
• Materials: Have Chinese-language materials (e.g. brochures, presentations) about your company to share with your hosts. While your contact in the organization may speak perfect English, the decision makers in the company may not. It will be challenging for your interlocutor to convince others of your company or product's value if they are not equipped with Chinese materials.
• Dress Code: Government officials and top management dress formally for meetings, while business people at working levels may adopt a more casual style. If you're not sure, go formal - it will convey respect and seriousness. In the summertime, there can be a suggestion for men to "go casual". This means polo shirts or button-down short sleeve shirts, as opposed to suits and ties (or shorts - which are definitely not appropriate).
• Introductions:
  • Addressing others: Seniority is valued in China. It is important to address your counterparts by their title (Chairman, Director, etc.). Find out who the most senior person in the room is, and address them first.
  • Introducing yourself: Say your name clearly, and remember to state both the company you work for and your position. As a point of reference, know that Chinese will refer to their company first, then their title, and then their name when introducing themselves to others.
  • Handshakes: As in Canada, meetings often start with handshakes. Ensure that you are not too aggressive with your handshake. Don't be surprised if you are at the receiving end of a decidedly non-aggressive handshake. If things go well, you may also be on the receiving end of a prolonged handshake: anything goes. In western business contexts, you have probably found yourself in "squeezing" contests (among men): who has the stronger grip? In China, the question will be "who lets go first?" Don't be shy about holding on if your counterpart is enjoying the contact - it is meant well.
  • Giving/Receiving business cards: Similar to introductions, hand out business cards to the most senior official first. Chinese use both hands when giving and receiving anything of value, including gifts and particularly business cards; you should do the same as this is one of the first points at which you will make an impression. Take a moment to look at and acknowledge the individual's card. Have your own cards translated into Chinese on one side. Your title is important; this is how your hosts will determine who should be invited to meetings, what weight your words carry, and where you will be seated.
  • Your name: Having a Chinese name, ideally one with meaning rather than a transliteration of your English or French name will be taken as a sign of respect as well. The best approach is to have a local contact or native speaker help create one for you. A link to an online Chinese name creator is provided at the end of the document under "Useful Links".
• Seating Arrangements: The host will take the lead, and you will likely have a name card or designated seat based on your role in the organization.
• Meeting structure: Particularly in government circles, meetings may follow a fairly formal structure, with the senior member of the hosting party introducing himself/herself and colleagues, and then proceeding to state his or her views and position on the matter in question. Following this, the leading member of your party should do the same. Subordinate members of the Chinese party will not usually speak unless asked to do so by the most senior person; your observance of the same protocol (even if your management style permits a more fluid approach) will have the advantage of conveying who is in authority and who, within your own team, may have special expertise or authority in a given area.

Dining

Business often gets conducted during meals. As with business meetings, food and seating are determined by the hosts. The following points should be kept in mind when dining formally with the Chinese:

• Beginning to eat: Follow cues from your hosts and start eating when the hosts begin. There will be cold dishes placed on the table when you are seated; wait to be invited before you dig in.
• Keeping pace: At formal banquets and high-end restaurants, serving staff may keep up an almost constant rotation of dishes. They will also change your plate frequently with a clean one, so as not to mix dishes and flavours. While at first this may be distracting, accept the rhythm and you will soon cease to notice it. In order to have a sense of what is coming next, know that the meal will proceed with meats of various varieties and peak with a fish course, followed by a staple (rice, dumplings, noodles) and wind down with a sweet or dessert.
• Refusing food: The Chinese tend to offer a lot of food, and it is acceptable to refuse food if you have dietary restrictions or allergies. However, it is a sign of politeness to accept some of everything, and sample (even a little of) all dishes served. But don't eat or drink all of something you don't like, since this may be taken as a sign that you want more! This is where the rotation of plates can serve to your advantage: a nod to the wait staff to remove a plate will allow for your preferences to be accommodated unobtrusively.
• Drinking: While local wine can be preferred at banquets, the Chinese more frequently offer strong distilled alcohol called or maotai (a very special type of baijiu) for toasts - and there may be many toasts during a meal. Never drink from the toasting glass except during a toast - and don't let the size of the glass fool you as to the power of the contents! The Chinese know that their alcohol is considered strong for foreigners, and under normal circumstances, they will not push you to drink. Some hosts will provide drinking yogurt to help protect your stomach, which can be helpful to allay the effects of the alcohol. Try to avoid drinking baijiu on an empty stomach as you will feel the effects of the alcohol quickly - it's a good idea to eat something before the toasts begin. If you cannot or do not drink for medical or personal reasons, this is respected but you should advise your host or your working level contact of this at the beginning of the banquet, or even beforehand. It will be noted carefully by your hosts and arrangements will be made to avoid embarrassing you.
• Toasting: Your host will start off the banquet with a toast to your presence / friendship/ cooperation / getting to know each other / clinching a deal. You may choose to reciprocate, toast for toast, or to wait until the host, his or her colleague, and one other member of the hosting party has toasted. Typically, the principal guest is expected to toast a few courses after the host toasts. If you are toasting, your comments should be warm and sincere, and your toast should not be any longer than your host's. When toasting, the Chinese normally say gan bei, which translates to "bottoms up". Note that drinking is sometimes expected as proof of a close relationship where partners can reveal their true selves, even in a business context. While this expectation is slowly changing and may vary by region, it is something to be aware of. If the group at the banquet is very comfortable with each other, it is also not uncommon to go around the table toasting each member of the party. Take your cue from your hosts and from your local contact or interpreter.
  Note: There are great differences in dining and toasting customs among different regions in China. When in doubt, ask your host. He or she will be very happy to explain them to you and will be impressed at your interest in and respect for local customs.
• Conversation: The banquet is generally a social event in a formal context. Discussion will likely centre around pleasantries, background information on the region or the company, but it is not a time for negotiating or challenges. The focus may not be the food per se, but there will be pride in the offerings provided.
• Paying the bill: The host pays. If you are hosting a meal, do not show money in front of your guests. Either have someone slip out and settle the tab or wait until your guests have left before paying.
• Hosting the banquet: It is not common business practice to be expected to host a banquet at the conclusion of a deal. Certainly if you would like to host a banquet this is your prerogative, but it would be considered bad form in a business context for the Chinese company to insist you do so or provide you with the bill at the end of the meal.
• Concluding: There is little lingering at banquets. Formal dinners often end suddenly, when the senior member of the hosting party stands up (quickly followed by staff and subordinates), briefly thanks the guests for attending, and proceeds to leave the room. This may appear abrupt the first few times you witness it, but is simply a decisive and useful way to bring the occasion to a close. If there is a dessert / fruit course, you can expect this to follow fairly shortly before the senior member of the hosting party departs. Gifts (see below) are usually offered at the conclusion of the banquet, prior to departure.

Gift Giving

Gift giving is a common Chinese custom that business visitors to China should prepare for and use to advantage. The advice of a Chinese friend or colleague is invaluable in doing this properly, but here are some simple guidelines:

• Who: Typically, a single large group gift is presented to the chief person or leader of a Chinese organization. Gifts should be presented from the lead of the Canadian delegation to the lead of the Chinese delegation and vice versa.
• What: Gifts should not be too expensive. The gifts you receive will often have strong local associations that are a matter of real meaning (local identity) and therefore pride to the giver. The best gifts to offer in return will be items that are unique to Canada: small paintings, carvings, or books (keep your host's English capabilities in mind!) are appreciated and reasonable as gifts. The Chinese are fond of dark red, gold or blue, which are all appropriate colours for gift wrapping.
• When: Gifts are usually given at the end of an introductory meeting or at a banquet. Delegations visiting China are normally expected to offer gifts to their hosts, and the opposite is true for Chinese travellers to Canada. In both cases, this should be factored into preparations for making a trip or receiving an incoming delegation in Canada.
• How: Always give and receive gifts or anything of value with two hands. Note that it is common in China for the recipient to refuse the offer of a gift at first. The giver should persist, and the recipient will eventually accept.
• What Not to Give: Gifts to avoid include clocks and scissors or other sharp items such as knives or letter openers. Avoid wrapping gifts in white or black, which are colours associated with funerals.

Useful Links and References

• Mandarin Tools
  This link is a good place to start for creating a Chinese name, but ensure that you have a native Chinese speaker check over your name before use.
• Kwintessential
  This link provides a concise overview of Chinese culture, customs and business etiquette.
• Chinese Culture
  This link discusses Chinese culture and how it relates to the business environment.
• Netique
  The link provides a useful guide to gift giving in China.

Books

• One Billion Customers by James McGregor
• Chinese Business Etiquette: A Guide to Protocol, Manners, and Culture in the People's Republic of China by Scott Seligman

[ 1] Important Note: The Embassy of Canada and Consulates in China periodically become aware of various scams perpetrated by Chinese companies. One of the most recent is characterized by an unknown Chinese company approaching a foreign company for a large purchase order of substantial value. The company will insist on an agreement to contract very quickly, at which point they will insist that the foreign companies come to China for contract signing and payment of the notarization fee (typically, a certain percentage of the contract value). It is not mandatory business practice to notarize a contract in China, nor to be required to contract in front of a notary office and share the notarization fee. Should you be approached in this way, beware!

The other day I received an email from a college student looking to form a business that would buy product from China and sell it in the United States. The email asked about the steps to take to get such a business going. Here is that email (modified slightly to maintain the anonymity of its sender):

I am an American college student studying International Business and Chinese at ______ University. This past semester while studying abroad at in China a friend of mine, _______ (who met you in Chengdu), turned me on to the China Law Blog.

A few friends and I have decided to start a company soon after graduating next May. The company will produce and sell product X, starting in the U.S. and then moving to China and elsewhere abroad. Right now my friend's father is developing the prototype product X, which is coming along with great success. In the meantime, we our trying to structure the company and figure out the logistics of the start-up.

I'm seeking your advice because we want to manufacture product X in China but don't know how to get started. I have often read your articles describing the risks/dangers of manufacturing there, and I want our company to approach the production of our product in a smart, cautious way. Once the prototype is complete, how do we go about finding reliable manufacturers in China for our product? I know about the importance of protecting IP rights and (some of) the differences between contracting in China vs. America, but I want to know: what is the next step after the our prototype is complete and we have buyers? Where should we go from here??

Thanks a lot for your time and consideration! I hope to hear from you soon.

I responded as follows:

Thanks for writing and thanks for the loyal reading.

1. Form a US company (probably an LLC) and have a good member agreement drawn up among the owners. Hire a local lawyer for this.

2. Make sure your IP is protected in your primary selling market (the United States?). I doubt you will have anything that can be patented, but that should be a consideration. Patents are very expensive, however. If you are going to call your product, product X (that sounds good to me), you should trademark that in the United States.

3. Now find the manufacturer. There are many ways you can go about this. The best and usually the cheapest is to do tons of internet research and then narrow it down to 4-5 and then fly to China and meet with those factories. If you are going to be doing something really different than other people making this product, you should require the factories sign a Non Disclosure (NDA) Agreement (read about these on the blog) before you show them anything. This should be in Chinese and in English. The alternative is to hire a sourcing company to find the right factory for you and to negotiate on your behalf. If you choose that route, we can give you names of the people we know and trust who do this. These people can also usually help with things like shipping as well.

4. Then have a really good agreement with the manufacturer and you need to trademark your product name in China and you should be good to go (assuming your product does not call for a China patent). This agreement with the manufacturer is called an OEM Agreement, a Manufacturing Agreement or a Supplier Agreement and this should be in Chinese and in English as well.

I am sure I have left out a few things, but the above are the basics.

Good luck.

What do you think?

Though we often talk generally about what it takes to form a company in China, a reader recently pointed out to me that we have never set out the basic steps one must take to do so. The following sets out the basic steps a foreigner usually must take to form a Wholly Foreign Owned Entity (WFOE) in China. For more information on what is required to form a company in China, check out How To Start A Business In China - WFOE and How To Start A Business In China - The Minimum Capital Requirements For A WFOE.

Forming a WFOE in China typically requires the following:

1. Make Sure Your Business is Legal For Foreigners. Determine if the proposed WFOE will conduct a business approved for foreign investment by the Chinese government. For example, until recently, China prohibited private entities from engaging in export trade. Be sure your business will be legal.

2. Provide The Proper Documentation. The investor in the WFOE must provide the documentation from its home country proving it is a duly formed and validly existing corporation or Limited Liability company, along with evidence showing who from the investor is authorized to execute documents on behalf of the investor. The investor also often must provide documentation demonstrating its financial adequacy in its home country.

3. Investor Documents Needed. The Chinese government normally requires the following documents from the investing business entity:

• Articles of Incorporation or equivalent (copy)
• Business license, both national and local (if any) (copies)
• Certificate of Status (original)(U.S. and Canada) or a notarized copy of the Corporate Register for the investor or similar document (original)(Civil Law jurisdictions)
• Bank Letter attesting to the account status of the investor company (original).
• Description of the investor's business activities, together with added materials such as an annual report, brochures, website, etc. The first four of these must be in Chinese. The last one may be submitted in English, with a Chinese summary.

4. Consider Forming a Special Purpose Company to Own the WFOE. Many investors create special purpose companies to serve as the investor in China. China's company regulators have become accustomed to this process. However, the Chinese regulators will often still seek to trace the ownership of the foreign investor back to a viable, operating business enterprise. It is common to form a Hong Kong company for this purpose and there are often tax benefits in doing so.

5. Secure Chinese Government Approval. In China, unlike in most countries with which Western companies tend to be familiar, approval of the project by the relevant government authority is an integral part of the company registration process. If the project is not approved, the company will not be registered.

6. Compile and Provide These Documents for Chinese Government Approval. The following documents must usually be prepared and then submitted to the Chinese government:

• Articles of Association. This document will set out all the details of management and capitalization of the company. All basic company and project issues must be determined in advance and incorporated in the Articles. This includes directors, local management, local address, special rules on scope of authority of local managers, company address, and registered capital.
• Feasibility Study. The project will not be approved unless the local authorities are convinced it is feasible.This usually requires a basic first year business plan and budget. We typically use a client produced business plan and budget to draft up the feasibility study (in Chinese).
• A Lease. An agreement for all required leases must be provided. This includes office space lease and warehouse/factory space lease. It is customary in China to pay rent one year in advance and this must be taken into into account in planning a budget because the governmental authorities will be expecting this.

7. Compile and Provide These Additional Documents for Chinese Government Approval. You will also usually be required to provide the following documents:

• Proposed personnel salary and benefit budget. If the specific people who will work for the company have not yet been identified, one must specify the positions and proposed salaries/benefit package. Benefits for employees in China typically range from around 30% to 40% of the employee base salary, depending on the location of the business. Foreign employers are held to a strict standard in paying these benefit amounts. The required initial investment includes an amount sufficient to pay salaries for a reasonable period of time (usually one year or more) during the start up phase of the Chinese company. These documents must be in Chinese.
• Any other documentation required for the specific business proposed. The more complex the project, the more documentation that will be required.

8. The Approval Process. It usually takes two to five months for governmental approval, depending on the location of the project and its size and scope. Large cities like Shanghai tend to be slower than smaller cities. The investor must pay various incorporation fees, which fees vary depending on the location, the amount of registered capital and any special licenses required for the specific project. Typically, these fees equal a little over 1% of the initial capital. On large and/or complex projects, the approval process often involves extensive negotiations with various regulatory authorities whose approval is required. For example, a large factory may have serious land use or environmental issues. Thus, the time frame for approval of incorporation is never certain. It depends on the type of project and the location. Foreign investors must be prepared for this uncertainty from the outset.

if you comply fully with the above, your chance of getting your WFOE approved is nearly 100%.

This post is a re-hash of a post Steve did more than three years ago. We are re-running it now as part of a series of posts we will be running over the next few weeks on the Basics of China Business Law. We are even forming a new category for this series, the first since we started this blog!

This post focuses on the forming of a Wholly Foreign Owned Entity (WFOE) in China. I am starting with this type of entity because it is the one we do most often. Subsequent posts will detail the steps required to register other forms of entities in China, such as a representative office (RO) or a contractual or equity joint venture (JV). Each of these forms of foreign invested enterprise (FIE) is subject to its own specific laws and to numerous regulations that apply to all FIEs. Every FIE is formed as a Chinese limited liability company (LLC).

Where the special laws and regulations of an FIE do not apply, the provisions of the Chinese Company Law control. The Company Law was recently completely rewritten to conform more closely to international standards for company formation and management.

The steps for forming a WFOE in China typically consist of the following:

1. Determine if the proposed WFOE will conduct a business approved for foreign investment by the Chinese government. For example, until recently, China prohibited private entities from engaging in export trade. All export trade was handled through certain large, state owned trading companies.

China recently abandoned this system, and now both foreign and domestic companies can set up trading companies. Restrictions on export oriented trading companies have essentially been eliminated, but there are still controls on import oriented trading companies that can increase expense and raise costs. Because these rules were only recently changed, the local regulators who must approve these projects do not have a great deal of experience with the attendant issues. This can lead to some delay in the approval process. It also results in an extremely cautious approach towards adequate capitalization even for export oriented trading companies. I discuss capitalization requirements in greater detail below.

2. Determine if the foreign investor is an approved investor. Basically, any legally formed foreign business entity is authorized to invest in a WFOE in China. China especially welcomes investment that promotes the export of Chinese manufactured products. The investor must provide the documentation from its home country proving it is a duly formed and validly existing corporation, along with evidence showing the person from the investor who is authorized to execute documents on behalf of the investor. The investor also must provide documentation demonstrating its capital adequacy in its country of incorporation.

To meet these requirements, the following documents are normally needed from the investing business entity:

a. Articles of Incorporation or equivalent (copy)

b. Business license, both national and local (if any) (copies)

c. Certificate of Status (Original)(U.S. and Canada) or a notarized copy of the Corporate Register for the investor or similar document (original)(Civil Law jurisdictions)

d. Bank Letter attesting to sound banking relationship and account status of the company (original).

e. Description of the investor's business activities, together with added materials such as an annual report, brochures, website, etc.

a-d are translated into Chinese. e is either translated into Chinese or summarized in Chinese.

Many investors created special purpose companies to serve as the investor in China . The Chinese regulators have become accustomed to this process. However, the Chinese regulators will still seek to trace the ownership of the foreign investor back to a viable, operating business enterprise. Investor secrecy is not an option in China. However, the corporate register for the Chinese company will merely state the name of the foreign, special entity investing company as the owner. In that sense, as far as public disclosure is concerned, the investor privacy can be maintained. The foreign investor should also understand that this tracing process will add some time and cost to the Chinese company formation process.

3. Chinese government approval for the project. In China, unlike in most countries with which Western companies tend to be familiar, approval of the project by the relevant government authority is an integral part of the incorporation process. If the project is not approved, no incorporation is permitted. The two are inextricably linked.

The following documents must be prepared for incorporation/project approval:

a. Articles of Association. This document will set out all of the details of management and capitalization of the company. Nothing can be left for future determination; all basic company and project issues must be determined in advance and incorporated in the Articles. This includes directors, local management, local address, special rules on scope of authority of local managers, company address, and registered capital.

b. Feasibility Study. The project will not be approved unless the local authorities are convinced it is feasible. This usually requires a basic first year business plan and budget. We typically use the client produced business plan and budget to draft up the feasibility study (in Chinese) that will satisfy the requirements of the Chinese approval authority.

c. Leases: An agreement for all required leases must be provided. This includes office space lease and warehouse/factory space lease. It is customary in China to pay rent one year in advance and this must be taken into account in planning a budget because the governmental authorities will be expecting this.

d. Proposed personnel salary and benefit budget. If the specific people who will work for the company have not yet been identified, one must specify the positions and proposed salaries/benefit package. Benefits for employees in China typically range from 32% to 42% of the employee base salary, depending on the location of the business. Foreign employers are held to a strict standard in paying these benefit amounts. The required initial investment includes an amount sufficient to pay salaries for a reasonable period of time during the start up phase of the Chinese company.

e. Any other documentation required for the specific business proposed. The more complex the project, the more documentation that will be required.

All of the above documents must be prepared in Chinese.

4. It usually takes two to five months for governmental approval, depending on the location of the project and its size and scope. Large cities like Shanghai tend to be slower than smaller cities. The investor must pay various incorporation fees, which fees vary depending on the location, the amount of registered capital and any special licenses required for the specific project. Typically, these fees equal a little over 1% of the initial capital.

On large and/or complex projects, the approval process often involves extensive negotiations with various regulatory authorities whose approval is required. For example, a large factory may have serious land use or environmental issues. Thus, the time frame for approval of incorporation is never certain. It depends on the type of project and the location. Foreign investors must be prepared for this uncertainty from the outset.

Tomorrow's post will discuss a WFOE's minimum capital requirements.

Yesterday, in a post entitled, " How to Start a Business in China - WFOE, " we discussed the basic requirements for forming a wholly foreign owned entity (WFOE or WOFE) in China. One of the questions we are most frequently asked about how to form a WFOE in China is is how much the Chinese government requires in minimum capital. This post follows up on yesterday's post by addressing the minimum capital requirements issue.

Every company in China must have a stated registered capital. This amount is provided in the Articles of Association of the company and is also noted on the company register. Beginning in 2006, this company register is available to the general public. The registered capital includes all of the components of the initial investment in the company, including its start up cash, contributed property, and transferred intellectual property. Where the registered capital is small, the entire amount must be contributed immediately upon formation of the company. If the amount is large, it may be contributed in installments. There are a number of schedules for the percentage and timing of large amounts of registered capital. It is a crime to state a registered capital amount and then fail to contribute. The purpose of registered capital is to provide some notice to creditors of the capital adequacy of the company. Because of this, Chinese regulators take very seriously the rules regarding registered capital.

Registered capital is an initial investment that is intended to be immediately used in operating the company. It need not just sit in a bank and never be touched. It can be used to pay salaries and rent, to purchase product, or for any other normal start up operating expense. Registered capital may include contributed real and personal property used in operating the business. Many foreign investors think registered capital is some sort of security deposit that they can never utilize. This is not true. On the other hand, some foreign enterprises believe they can simply withdraw their registered capital after the Chinese company begins normal business operations. This also is not true. Once the capital is contributed to the Chinese company, it can never be withdrawn for anything other than paying company expenses.

The only way to get funds from the Chinese company out of China is by repatriating profits or by liquidating the Chinese company. Both of these methods will work, but they both require paying Chinese taxes and meeting other requirements under Chinese law. Investors should also note that the RMB is not a freely convertible currency. For companies that will earn RMB income, the issue of conversion to U.S. dollars or other foreign currency should be carefully considered and a failure to abide by Chinese law all the way along the process will likely lead to an inability to get money out of China at some point down the road.

Under the new Chinese Company Law, the minimum capital requirement for multiple shareholder companies has been reduced to 30,000 RMB (less than $5,000 USD). For single shareholder companies, the amount is 100,000 RMB (around $13,000 USD). However, these numbers have no real meaning for the formation of a WFOE in China.

The real question is what the Chinese authorities will consider as adequate capitalization for the specific project. Of course, that answer varies by type of business and location. For example, it is very expensive to operate a business in Shanghai. On the other hand, it can be very inexpensive to operate the same business in a rural area of China. It is expensive to operate a capital intensive business like manufacturing, but relatively inexpensive to operate a knowledge based consulting business.

The Chinese regulators usually consider all of these issues. To complicate matters, each local regulator has its own basic standards on what constitutes adequate capital for certain types of business activities. These numbers are not published, but when asked they will almost always be provided. They can only be determined through direct contact with the regulator and only after providing a clear explanation of the project. The local regulator virtually never considers the statutory minimum in making a determination regarding adequacy of capital. Rather, the local regulator will determine what it believes is an adequate amount of capital based on all the circumstances. Once the investor has a clear idea of the outlines of a project, it is usually a good idea to engage an attorney to contact the local regulator to see what their response will be to the proposed amount of investment. This initial screening can save a lot of time if the investor's idea of the proper amount of capitalization is dramatically different from that of the local regulator.

In determining what constitutes adequate capital, one needs to consider the peculiar situation in China that building rents are virtually always paid in advance, that payment for products for sale are virtually always paid in advance, and that a reasonable advance reserve for salaries is also required. Thus, the initial start up costs are much higher than in a location like the United States, where credit and time payments are more common. In addition, the foreign investor needs to take into account the risk aversion of the Chinese regulator. The Chinese regulator will not approve a project that looks risky or under-funded. The regulator has no incentive to do this, especially for a 100% foreign owned entity.

The government sometimes permits the minimum capital to be paid in installments over up to two years, though the first installment must be at least 15% of the total amount required and it also must be at least the statutory minimum for total capital. The capital contribution can be made in money, equipment, intellectual property, or other transferable property, but the monetary contribution must be at least 30% of the total capital amount. The government will appraise the value of any non-monetary contribution and our experience has been that it will come in fairly low in its valuation.

We frequently see two big mistakes being made by foreign investors when it comes to their putting in the required minimum capital. Foreign investors hear that assets can be used as a contribution towards the minimum capital requirement, so they go ahead and ship certain assets over to China, with the expectation of then using those assets towards minimum capital. The problem with this approach is that unless the proper authorities have been notified and granted their approval in advance of the shipping, the assets you just shipped to China will not be applied towards minimum capital, and you will have a huge problem on your hands.

The other common mistake we see is the foreign investor putting a value on its assets (including its intellectual property) and assuming the Chinese regulators will put the same value on those assets in determining the contribution towards minimum capital. The Chinese regulators will require their own appraisal (at your expense) l of anything other than monetary contributions towards the minimum capital requirement, and those appraisals tend to come in low, particularly for IP.

Every few months we get an email from someone seeking our help to prevent the Chinese government (broadly defined) from shutting down their business. Something is definitely afoot in China right now as we received three such emails just this week. The following is a composite of these three emails:

We set up a WFOE and started a small XYZ business inside a residential compound in ______. The local authorities came knocking the other day, pointing out that it is impossible to license our venue for any sort of business - "our company legal address is necessarily elsewhere." Apparently there is only a title deed for the entire complex, which was built some 5 years ago. We have the property management company fully on our side, but they seem unable to do anything, or don't know what to do. They have said that they intend to close us down. Just so you know, we are registered as a consulting company, not an XYZ business.

We would really like to have this resolved asap, as we will otherwise need to lay off our staff. Is there anything you can do?

We write back suggesting they retain local Chinese counsel. But what we really want to say is the following:

Dude, you have a big, probably insurmountable problem. And it is entirely of your own making. You no doubt used a cheap entity formation company to form your WFOE and, unfortunately, they went along with what you knew was illegal. Your business is illegal in four ways and there is no way a bunch of American lawyers can solve a problem like that.

Not that I need to tell you this, but just to be clear, your business is illegal for the following four reasons (and this is just what I am able to glean from your five sentence email:

1. You registered your business as a consulting company but you are operating as an XYZ business. I'm guessing you did this because you wanted to keep your required minimum registered capital low.
2. Your registered address is "necessarily elsewhere" because to register as a consulting business, you needed an office and your XYZ business is not an office.
3. Your XYZ business location can never qualify as a legitimate WFOE because to do so you need your own separate space and where it is located (as you point out by saying there is only one title for the entire complex) constitutes just one business location.
4. Your lease is illegal and that is why your landlord cannot help you. It sounds like your landlord is not authorized to lease out a part of the property for a business. The area in which the building is located is almost certainly not zoned for business.

I really don't know what else to tell you other than that you had better get to a good local Chinese attorney and fast.

In " How To Form a China WFOE. Scope Really Really Matters, " we talked of how the scope you describe in your initial WFOE application matters even after your WFOE is approved:

BUT - and this is why I am writing this post now - if you under or overreach on the description of your business scope, you might find yourselves in big trouble. We are getting an increasing number of calls from American companies in trouble with the Chinese government for doing things in their business that were not mentioned in the business scope section of their initial WFOE.

In some cases, the companies have admitted to us that they were never "really comfortable" with the business scope mentioned in their applications, but that the company they had used to form their WFOE had "pushed" them into it as it would "make things much easier." In some cases, the scope of the business changed after the application was submitted and the company had failed to secure approval in advance for the change. And in some cases, the company probably would never have been approved at all had it been upfront and honest in its application. In nearly all instances, the companies had managed to secure local approval but were now in trouble with Beijing, which constantly is auditing these applications. In one instance, the local government went back and changed its mind, probably after conducting an audit of its own.

I cannot go into any more detail on these matters, but I can give this advice: applying for a WFOE in China involves a heck of a lot more than just filling out a form and getting approval. It does matter for what you get approved and you (or whomever you are using for your WFOE application) need to know China's foreign investment catalog inside and out before applying. You then must tailor your application to meet both the requirements of the foreign investment catalog AND the reality of what you will be doing in China. A failure to comply on both fronts will lead to, at best, a rejection of your application and, at worst, being shut down months or years later.

If you take away nothing from this post, please at least understand that your getting local government approval for your WFOE does not mean you are out of the woods. There is little to no benefit in getting approval for a non-conforming WFOE.

In Leasing Requirements For A China WFOE To Be, Part II, we talked about the importance of having a valid lease for your WFOE and we even went so far as to say that without such a lease, you shouldnt' even bother having a WFOE at all:

If you are not going to get the right space for a WFOE, you are probably better off not getting a WFOE at all. Registering a WFOE and then not complying with ALL of the requirements for having a legally operating WFOE is a classic example of trying to operate quasi-legally in China. For why this is a bad idea, check out " Quasi-Legal In China. Not The Place You Want To Be" and " Forming A Company in China. Do It Right Or Do It ALL Wrong, But Don't Do A Rep Office. "

The Bottom Line: We have said it before and we will no doubt say it again. Form your WFOE correctly or don't bother forming one at all. China's economy is on the decline and that means it will be looking to get rid of foreign companies operating illegally. If your WFOE is not living up to its registration requirements/promises, you are at risk.

What are you seeing out there?

I am always saying that for every 100 China WFOEs and Joint Ventures my law firm helps set up in China, it does one representative office. Why so few, when it is generally agreed that representative offices are the easiest type of offices for foreign firms to set up in China? Because the inherent limitations on China Rep Offices mean they seldom make sense.

Rep Offices "represent" in China the foreign company back home. Rep Offices are not a separate legal entity; they are the China representative of the foreign company. Most importantly, they are not allowed to engage in profit making activities. Chinese law limits them to performing "liaison" activities. They cannot sign contracts or bill customers. They cannot supply parts and after-sales services for a fee. NOTE: This post does not discuss branch offices for banks, insurance companies, accounting and law firms, that are permitted to engage in profit-making activities.

Rep Offices are pretty much limited to engaging in the following:

• Conducting research.
• Promoting their foreign company.
• Coordinating their foreign company's activities in China.
• Other activities that do not and are not intended to generate a profit.

Because forming a Rep Office in China is faster, cheaper and easier than forming a Wholly Foreign Owned Entity (WFOE), companies oftentimes consider forming a China Rep Office as a way of "putting their toe into the water" there. These companies typically intend to switch over to a WFOE once it becomes clear China will be viable for them.
My firm generally discourage this "Rep Office and then a WFOE plan" because "switching" from a Rep Office to a WFOE is not really a switch at all. Making that switch in China will involve both shutting down the Rep Office and then forming a WFOE pretty much from scratch. Because the cost of forming a Rep Office, shutting down the Rep Office, and forming a WFOE, will be considerably more than just forming a WFOE, forming a Rep Office with the later intention of forming a WFOE does not usually make sense and most companies will be better off just biting the bullet and forming the WFOE straight away.

Other times, companies have come to my law firm believing they need a China Rep office because they need a Chinese entity to sell their product into China. Oftentimes these companies can sell their product into China without having to create any in-china footprint at all. So long as they are not going to have much need for people in China, they oftentimes can get away without forming a company in China at all.

But there are definitely times where a Rep Office makes sense. By way of one example, my firm set up a Rep Office for a US company that sells US made equipment for around $2 million each. This company has no plans to start manufacturing its equipment in China so there would be no need to form a WFOE for that. It already had an arrangement with a Chinese company to repair its equipment sold into China, so no need to establish a WFOE for that purpose either. This company merely wanted an on the ground China presence to improve its sales and to let its customers and potential customers know it is serious about China.

China Rep Office applications typically go through the Administration of Industry and Commerce ("AIC"), though some industries (banking, insurance, legal, accounting, airline, media, and some others) also require an additional approval from the Chinese government agency with jurisdiction over that particular industry. All applications must be submitted by a designated/authorized Chinese agent (often known as a Foreign Enterprise Services Company or "FESCO") in the locality where the proposed representative office is to be established.The application involves submitting fairly standard corporate documents from the foreign company, along with a copy of the lease agreement showing the Rep Office is leasing legitimate business space in China.

MOFCOM usually takes around thirty days to approve a Rep Office. One interesting feature of China Rep Offices is that they are not permitted to hire employees directly; they must be staffed indirectly through a FESCO. Nonetheless, it remains the responsibility of the Rep Office to make sure its FESCO employees have signed off on Rep Office company policies, including on such things as confidentiality. In all instances where we have formed a China Rep Office for our clients, we also have drafted the employment agreements the FESCO must use with the employees. That way we can be certain the agreements best protect our client.

For more on Rep Offices in China, check out the following:

I often get calls from companies that want to get their product into China or increase sales there. Many times, they are under the false impression that they have two choices: go it alone or form a joint venture with a Chinese company. Entering into a distributorship relationship with a Chinese company (or companies) is another option. From a strictly legal perspective, distribution relationships between foreign and Chinese companies are actually fairly straightforward and are far easier and generally less risky than joint venture deals and typically far less costly and time consuming than going it alone.

From a business perspective, taking most products into China (be they industrial or consumer), marketing it, selling it, and then delivering it, is a massive task for any foreign company. I hate to trot out a cliche, but China is a big and diverse country and it should be viewed as many markets, not just one. Yet with China's wealth rapidly increasing, it is the rare company that is not at least desirous of adding China to its list of markets. China is becoming a consumer/buyer nation.

We have written a number of times about some of the issues foreign companies face in getting their products sold in China, including in the following posts:

Distribution contracts with Chinese companies can have much in common with US and European distribution agreements, but they also have stark and interesting differences. The United States and Europe generally provide distributors with all sorts of legal protections. These countries often make it difficult or expensive to terminate a distributor and it is not at all unusual for distributors in these countries to sue or threaten to sue when a distribution relationship sours. Chinese law has no special protections for distributors. In particular, there is no legal requirement in China for payment of any special compensation to a distributor upon termination of the distribution agreement. For these reasons our China distribution agreements call for applying Chinese law. For these same reasons, we usually do not bother with provisions devoted to trying to work around distributor protections.

One big issue in China (of course) is IP protection and so it usually makes sense to put into the distributor agreement what we call a "no registration" provision to further protect our clients' China trademarks. In this provision, the distributor agrees our client has exclusive ownership of all trademarks or other IP that might be at risk, that the distributor gains no rights to those trademarks, and that the distributor will not register any IP in any way related to our client's IP. I use the words "further protect" because the first line of protection for your trademarks in China is to register them properly in China.

One other difference between a Chinese distribution agreement and that for the United States or Europe is that the signature line in a Chinese distribution contract should provide a place for the distributor to affix its company seal; unsealed distribution contracts are arguably not valid under Chinese law.

Since China's Anti-Monopoly Law prohibits retail price maintenance (requiring someone like a distributor sell the goods at a minimum resale price to third parties), distribution agreements generally must not mandate that the distributor sell its goods at a certain price to retailers or consumers.

Anyway, do not forget the possibility of using a distribution relationship to get your product into China as they can be both relatively simple and effective.

What are you seeing out there?

Santiago Cueto of the International Business Law Advisor Blog did a post, entitled, 6 Key Provisions You Should Include in Your International Licensing Agreements. I borrow extensively from that post for this one, which is more tailored towards China. I list out Santiago's tips in bold and then provide his explanation in normal font and then my comments in italics, I explain how they relate to any licensing agreement you might have with a Chinese entity. This post is formulated towards assisting a Western company looking to secure royalty payments by licensing its technology to a Chinese entity.

Again, please note, all of the below in normal font is directly from Santiago's post. My comments are italicized.

Exclusive Property Rights. Preliminarily, before you start negotiating a license agreement, make sure you have exclusive property rights. While the law often changes in this area, the best way to lock in your rights is to register for any or all of the following that apply to your situation:

Copyrights - original works of authorship fixed in any tangible expression form

Patents - inventions

Trademarks - words, names or symbols identifying goods made or sold, distinguishing them from others

The application process can be rigorous, and you may have to disclose your ideas publicly. So you may also want to further protect your intellectual property by relying on laws. Generally, these laws protect internally guarded ideas, formulas, codes or other information giving a business competitive advantage. A good example is source code to software.

6 key provisions I've selected 6 key provisions that should be included in your foreign license agreements:

1. Approval of licensed goods. When major US manufacturers license products to companies abroad, they often arrange periodic inspections of the manufacturing facilities to ensure the quality of the goods (and also to monitor whether the licensee is siphoning off products or engaging in illegal labor practices). This offers you some assurance of consistency and quality for your work.

2. Royalties and accounting. Payment of royalties from a foreign licensee can get tricky, especially when you consider issues like:

* currency conversion rates (probably best to always insist on payment in US currency)

* how the money will be paid (best to use wire transfers), and

* what taxes may be applied against your sales or royalties (before signing the license, inquire into national or local tariffs or taxes that may apply). Also, it's wise to include an audit provision (which allows you to inspect the foreign licensee's books).

3. Jurisdiction. Sometimes referred to as personal jurisdiction, jurisdiction is the power of a court to bind the parties by its decision. Unless the company does substantial business in the states, the only way to get a foreign licensee into a US court is to include a provision in the license agreement that requires the licensee to consent to US jurisdiction.

4. Choice of law. Every country (and every state) has laws as to how contracts are interpreted. The licensee will want the disputes to be resolved under the laws of its country. Try to include in your agreement that disputes will be resolved under US law for copyright purposes and the laws of your state when it comes to contract issues.

5. Arbitration. In arbitration, instead of filing a lawsuit, the parties hire a neutral arbitrator to evaluate the dispute and make a determination. You'll almost always benefit by agreeing to have disputes arbitrated and inserting this in your agreement. If possible, your agreement should award attorneys' fees to the prevailing party in the arbitration.

Try to get the licensee to agree to arbitrate the matter in the United States. If the licensee does not agree, there are three popular spots for international arbitration:

* London (The London Court of International Arbitration)

* Paris (The International Court of Arbitration of the International Chamber of Commerce), and

* Stockholm (The Arbitration Institute of the Stockholm Chamber of Commerce).

6. Foreign registrations. If your works are protected by US intellectual property laws like copyright or design patent law, you should determine whether it's worth your while to obtain foreign copyright or patent registration in the countries where your work is being manufactured or distributed (this will be the subject of a future post).You may be able to require that the licensee handle these administrative tasks.

For more on licensing technology to China, check out the following:

China Intellectual Property (IP). I Hate Cats, in which we give the following advice to help assure payment from those to whom you license your IP:

Base your pricing on the assumption that you will not get full payment on your final payments.

Do whatever you can to make sure the Chinese company still needs you at the end of the deal so that the Chinese company has no choice but to keep paying you.

Put in some killer provisions in your contract that deal with a situation where the Chinese company stops paying at the end.

What are you seeing out there in the world of China technology licensing?

The other day, Steve and I were emailing with a reporter regarding on how Memoranda of Understanding, commonly called an MOU, are so different in China than in the United States and how that difference often causes early discord between Chinese and American companies.

Steve started the discussion by talking about the differences in the meaning of Mermoranda of Understanding (between China (an essentially civil law country) and the United States (a common law country):

In the common law tradition like that in the United States, an MOU means little. Only a signed deal really counts. This is not true in the civil law tradition. In the civil law tradition, there is the concept of good faith negotiation. Under that concept, it is not acceptable to simply walk away from an MOU if that would constitute "bad faith." Common law lawyers hate the concept, but it is deeply ingrained into the civil law tradition. In fact, it is a core concept in the Chinese contract law of 1999. Since the traditions are so different, you can see where conflicts may arise.

In practice, the Chinese side often will try to turn an MOU into a concrete commitment when it suits them and ignore it when it does not. This is how most people behave and it should be no surprise. The problem is that under Chinese law the Chinese side might be justified in insisting that the MOU is binding if the behavior of the foreign side constitutes bad faith.

What is bad faith? The standard example is signing a China MOU and then negotiating with two parties at the same time without informing the two parties and using the MOU to keep one party from taking the initiative on a venture. And then sign a deal with the other party, cutting the first party out of the deal. This sort of strategy is not rare in common law countries, particularly in the mining/minerals and other natural resources businesses. Under the common law, the party cut out under this scenario usually has no claim. Under Chinese law and under civil law, the party that has been cut out has a claim under the bad faith doctrine.

Very few common law lawyers are even aware of this issue or they say that the Chinese are "wrong." However, China is a civil law country. It makes no sense to say the Chinese are just wrong. In fact, to the extent that the matter is subject to Chinese law, the Chinese are "right" by definition.

I then talked about how this difference in laws can so often lead to problems arising between Chinese and American companies:

The impact of this difference is that we frequently see the following: American company comes back from China and shows me their five page MOU and says that they now want to work on a contract . I tell them that what they have given me is probably a contract. They tell me that I'm wrong. I tell them to tell their Chinese counterpart that they now want a contract and see what happens. Virtually every time, the Chinese company tells the American company that there is no need for a contract and then the American insists that there is and then the Chinese party thinks the American is being a jerk. The parties have already gotten off on the wrong foot.

Steve then summed up the problems:

Dan's point is dead on. There is a major gap in legal systems here. It is not culture, it is the legal system itself. Both sides are behaving in a manner completely consistent with their own legal system. But in the end, both sides look to the other as though they are acting in bad faith, when in fact both sides are doing nothing more than trying to reach a deal as best they know how.

I then concurred with Steve:

Correct. And the thing is that neither side has malovent intent. The Chinese side just puts a lot more stock in the MOU than the American side. The American side will sign the MOU thinking its nothing and planning to come back and turn it over to their attorneys to draft the final agreement.

And then the problem starts when we tell the American company that the MOU it just signed is almost certainly a legally binding contract and that it is virtually certain that the Chinese side sees it as a contract and that the contract is terrible and that "it needs the following ten things." The American company then goes back to the Chinese company with the ten things that need to be changed or added and the Chinese company then gets offended because it thought it had a deal and only super minor things needed to be resolved and those would be resolved over time. So now you have a situation where what could have been a good relationship starts off on the wrong foot or fails to start off at all.

Bottom Line: MOUs are different in China and failing to realize this can lead to problems.

What do you think?

Probably 99% of the Non Disclosure Agreements we see that have been used "quickly" by American companies with their potential Chinese counter-parties are defective, usually terminally so. One of the things that most frequently makes them defective is that they call for disputes to be resolved in the United States. The problem with that is that Chinese courts do not enforce US court judgments and so even if the American company were to prevail in the United States, they typically have no recourse against the Chinese company unless the Chinese company has assets in the United States. Knowing this, the Chinese company feels free to violate the NDA with impunity.

A China NDA should not be simply pulled "off the shelf" because an "off the shelf" U.S. style NDA is just not going to work. I am not going to tell you that NDAs with China need be super complicated, because they don't. But I am going to tell you that they need to be done right and that means not just pulling something off the shelf. In fact, when we do these sorts of agreements with Chinese companies, we nearly always do them as an NNN (Non Disclosure, Non Use/Non Compete, Non Circumvention) Agreement, not just an NDA. We also ask a fairly long list of questions to our NNN client so as to tailor the NNN to its specific situation and to thereby maximize the likelihood that it will not be breached by the Chinese counter-party and to provide the best chance of recourse if it is. To a certain extent, these two goals are the same in that providing the best chance of recourse against a Chinese company is what is going to have the most impact on preventing that company from violating the agreement.

We ask the following questions before we begin work on NNN Agreements for our clients (along with follow-up questions based on the answers):

1. Please provide us with a one or two paragraph description of what you will be doing in China that you want to be covered by the NNN agreement. Note that what what we mean by an NNN agreement is: 1) Non-disclosure, 2) non-use/non-compete and 3) non-circumvention. For China, 2) and 3) are far more important than 1). The danger with Chinese manufacturers is that they will use the idea you provide them for their own production and that they will then attempt to sell that product to your own customers. These actions are what we seek to prevent through the NNN agreement.
2. Provide the full legal name of your company, including state/province/country of formation.
3. Provide the address and related contact information that you will want for the agreement.
4. Provide the name and title of the person from your side who will execute the agreement.
5. Does your company have a Chinese name? If so, what is it?
6. Will you use this agreement for a single product or for multiple products?
7. What is the best way to identify the products for which the agreement will be used? Please provide us with a clear, descriptive name that does not require attaching specifications or other proprietary information. Sometimes, even the name is proprietary. So we want to develop a designation that is clear but that does not reveal more than you want to reveal.
8. Will you use this agreement with a single potential manufacturer or with multiple manufacturers?
9. What types of information will you be providing to the Chinese side that would be protected by the NNN agreement. Our clients range from providing a general concept all the way to providing the full production specifications as the preliminary to a hard price quote.
10. Will you expect the Chinese side to do any design work during the initial discussion period?
11. Is your product protected by trademark, copyright or patent anywhere in the world? Where? What about China?
12. After you disclose this product in China, are you interested in preventing the Chinese side from contacting any of your existing customers concerning your product or related products? If so, do you want a general prohibition or do you wish to attach a specific list of persons/companies that the Chinese side should not contact (a "No Contact List").
13. We normally require the Chinese manufacturer NOT contact any potential sub-contractors who would work in the production process. Please advise if you believe that this would be a concern in your situation. Note that some Chinese "manufacturers" are not actually manufacturers. They serve only as a "middle man" for the actual manufacturers. If you use that kind of company, they will need to be able to discuss your product with their subcontractors and we will need to allow for this.
14. Please advise on any specific technology items that you wish to have protected in a heightened manner.
15. Note that this Agreement will apply only to PRC China manufacturers. It does not cover Taiwan or Hong Kong or Macau companies that may handle manufacturing for you as intermediaries. If you will be dealing with companies from Taiwan or Hong Kong or Macau (or from any country other than the PRC), please let us know so we can make allowances for that.
16. Note that the NNN agreement applies only to the preliminary negotiation stage for your product. If you move on to production, you will need a formal OEM agreement. If you will engage the Chinese side to do design, you will need a formal design agreement. The NNN agreement is NOT a replacement for these other agreements.

For more on China NNN Agreements, check out the following:

The other day, I did a post on why Non-Disclosure Agreements are so often critical for those doing business with China. Within a few hours of that post, entitled, " China Non Disclosure Agreements (NDA). A Really Good Thing," my co-blogger, Steve Dickinson, was pointing out how if we were going to talk about non disclosure agreements (commonly referred to as an NDA), we should also discuss how and why we nearly always recommend such agreements contain non-use and non-circumvention provisions as well. I agreed with Steve, suggested he write such a post, and, voilà, here it is:

Most lawyers tell their clients who are doing outsourcing work in China that they need an NDA. Many businesses I work with see this as an example of an attorney demand with little practical application. They see the typical NDA as an unnecessary and unenforceable "piece of paper" that they only use if their legal department forces them to do so. The normal comment I receive is "1) how can I prove the information was revealed, 2) how can I prove what was revealed was actually confidential and 3) how can I enforce the agreement even if I could prove the facts?" I am usually dealing with experienced business people and, frankly, their concerns are well founded. In fact, most of the NDAs I see in China are useless because they are both directed at the wrong issues and are unenforceable. Pulling your English language NDA and having it translated into Chinese is pretty much a complete waste of time.

When we work with sourcing companies and related OEM manufacturing arrangements, we almost never just draft a "straight NDA." Instead, we draft a "non-disclosure/non-use/non-circumvention agreement" that we refer to as an NNN Agreement. When a foreign company contracts with a Chinese company to manufacture a product, the NNN focuses on the three primary "bad acts" that the foreign company needs to prevent:

1. The foreign company does not want its design revealed to a third party. To prevent this, a non-disclosure agreement is required. Though this is an important issue in China, disclosure to an entirely unrelated third party is actually fairly uncommon. The bigger risk is disclosure to a related party. Many Chinese businesses have multiple subsidiaries and manufacturing is often done through a large network of subcontractors. Chinese companies are quite relaxed about passing around information within this network. A good non-disclosure agreement must focus on control of information within a network that the Chinese manufacturer itself may not consider as falling within the scope of a non-disclosure requirement.
2. The biggest concern of the foreign company is usually not disclosure to a third party. The real concern is that the foreign company does not want the Chinese manufacturer to make use of the product design to compete with the foreign company. For this purpose a non-use agreement is required. A good non-use agreement focuses on two issues. First, the agreement identifies the applicable intellectual property or confidential information of the foreign company and then authorizes the Chinese manufacturer to use that property/information solely to manufacture the product for the foreign company. Second, the agreement requires the manufacturer agree not to manufacture the product or any similar product under any circumstances, other than for the foreign company. This second provision is the most important as it prevents the Chinese manufacturer from manufacturing a similar product under its own trademark. Since many products are not covered by patent or other IP protections, the only way to prevent such "copy-cat" manufacturing is with such a non-use provision. Normal IP protections will not work, so a contractual agreement is essential. Virtually all "off the shelf" NDAs fail to account for this.
3. The foreign company also does not want the Chinese manufacturer to go around the foreign company by selling the product directly to the foreign company's existing or future customers. After the Chinese manufacturer has manufactured the product for some time, it will likely have learned about the market and the customers for the product. It is only natural for the Chinese manufacturer at some point to go to the ultimate customer and say: "Look, WE are the company ACTUALLY making this product and since there is no patent or other IP protection applicable to the product, why don't you just buy the product from us, for less?" This is called circumvention and it is extremely common in China. If you want to avoid getting "cut out" in this way, a non-circumvention agreement is required. Again, an "off the shelf" NDA is not going to cover this.

Most non disclosure agreements I see are just modifications of the standard NDA used in the United States or in England and those agreements simply do not deal with the special problems of related parties in China and they treat non-use/non-circumvention either inadequately or not at all. Only a carefully thought out NNN Agreement that thoroughly resolves treats all of these issues is of any real value in China.

Stay tuned, as the day after tomorrow we will talk about the other typical fatal flaw of "off the shelf" NDAs and why those NDAs are usually not enforceable in China.

This is part II of our series on what are commonly referred to as non disclosure agreements or NDAs. In Part I, " Why Non Disclosures (NDAs) Alone Are Not Enough For China, " we talked about how many companies are using inadequate, off the shelf American NDAs in China. Those agreements are inadequate for three primary reasons. First, they typically fail to cover internal disclosure within a network. Second, they oftentimes fail to prevent the Chinese signing party from manufacturing or using the product or information sought to be protected. To remedy this, non-use provisions are required. Third, they usually fail to prevent the Chinese signing party from circumventing the foreign company by going directly to the foreign party's customers or clients. To remedy this, non-circumvention provisions are required.

But even if these NDA agreements were to account for the three issues discussed in Part I and more briefly above, most of the ones we see would still not be worth the paper on which they are printed because they are pretty much unenforceable in China. Let's let co-blogger, Steve Dickinson, explain:

Most NDA agreements I see are just modifications of the standard NDA used in the U.S. The non-disclosure provisions do not deal with the special problems of related parties in China and the non-use/non-circumvention is treated inadequately or not at all. Only a carefully thought out NNN Agreement (non-disclosure, non-use, non-circumvention) that treats all the issues is of any real use in China.

Even the best agreement is of no use if it cannot be enforced. This is the other major defect of the typical NDA agreements I review: the agreement is usually not enforceable. It is absolutely required that an NNN Agreement be enforceable in China. And yet, most of the NDA agreements I read are governed by U.S. or English law with enforcement by litigation in the U.S. or England or by arbitration outside of China. This approach is almost always useless. U.S. courts almost never have jurisdiction over Chinese companies, so a judgment from a U.S. court is of no value. Arbitration outside of China is expensive and slow and proof is difficult or impossible and denies access to injunctive type remedies that would be available for arbitration in China.

To greatly increase your chances of having an NNN Agreement that will actually be enforced, the following nearly always makes sense:

1. The Agreement must include an accurate translation into the Chinese language.
2. The agreement must provide for enforcement through litigation in a Chinese court or through CIETAC arbitration. To further ensure that the NNN Agreement will be enforced, the NNN Agreement should provide for specific monetary damages that will be awarded in the case of a breach. Though U.S. and other common law systems sometimes discourage using this sort of liquidated damage provision, the Chinese system is the opposite. Specific contract damage provisions are encouraged since they ease the court's work.
3. Most NDA type agreements rely almost exclusively on injunctive relief as the primary enforcement mechanism. This is a a major mistake in China. The preference for injunctive relief in common law systems (such as the United States or England) is because it is often difficult or impossible to prove the amount of economic damages that result from a breach. This is not really an issue under Chinese law, where parties to a contract are encouraged to set a fixed amount for damages that will result from a breach. If written correctly, the liquidated damage amount sets a floor on damages, but if actual damages exceed that amount, it is permissible to seek damages for the excess. In addition, money damages and injunctive relief are not exclusive. A court or arbitrator is free to order that damages be paid and that the infringing/breaching party terminate the infringing action.

NNN Agreements that set forth a specific damage amount that will result from a breach make the cost of a breach clear to the Chinese manufacturer and if set high enough, will go a long way towards discouraging a breach. Having a properly written liquidated damages provision in your NNN Agreement also makes for quick and effective litigation/arbitration, which is much to the advantage for the damaged party.

Many Chinese manufacturers quickly sign the traditional poorly drafted and unenforceable non disclosure agreement without even thinking about it. Why is that? Because they know that their signing it comes with little to no risk.

When a Chinese manufacturer sees a well drafted NNN Agreement, they will sometimes resist signing. For some manufacturers, the reason is simple. Their whole reason for doing your outsourcing work is to acquire your technology and designs for their own products. So long as your technology is not protected by patent or trade secrecy law, and you have failed to require the Chinese manufacturer sign a strong NNN Agreement, the Chinese manufacturer is free to use your technology for its own purposes. Absent an agreement that prevents them from doing otherwise, it is perfectly legal for a Chinese manufacturer to use your unprotected information for their own products manufactured under their own trademarks. However, if an NNN Agreement makes clear that the Chinese manufacturer cannot appropriate your technology and contacts, then the manufacturer that wanted your OEM manufacturing solely for these reasons is no longer motivated to enter into the arrangement with you.

Sometimes the manufacturer has more complex reasons for refusing to sign a well drafted and enforceable NNN Agreement. A well drafted and enforceable NNN agreement shows the Chinese manufacturer that the foreign party knows its way around China and that it plans to hold the Chinese manufacturer to the terms of their contractual commitments. For this reason, the Chinese manufacturer may reasonably decide it would be better off just manufacturing for those foreign companies that do not manifest an intent to hold the Chinese side to their commitments.

Therefore, using a well drafted and enforceable NNN Agreement does actually increase the risk that the Chinese side will refuse to sign. However, we see this as a good thing. If the Chinese side has a good reason for not signing, they will say so and the agreement can be modified to account for that. If the reason for the Chinese side refusing to sign is not a good one, the Chinese side will be forced to make this clear also. In either case, the foreign company benefits from finding out in advance what is really going on. This "advance notice" function is one of the main advantages of a good NNN Agreement; it forces both sides to face up to the real situation and to engage in a frank discussion of what is really required for a successful and long term relationship. This is a much better situation than ritually executing a meaningless agreement.

Every few months or so, I see something that reminds me of how important it is to file your trademarks in China before anyone else does. I often tell clients that filing a trademark is about the only China legal no-brainer. Or as I said in a post from earlier this year, entitled, " China: Do Just One Thing. Trademarks, " if you do nothing else to protect your company in China, register your trademarks.

Apple Computer is learning the importance of being first to file a trademark in China. Apple just lost a lawsuit in China against Proview Technology over ownership of the iPad name. Proview Technology filed a trademark for the iPad name in China back in 2000 so my initial reaction to the lawsuit was that Apple had zero chance of prevailing. China is a first to file country, which means whoever files for a trademark first (with only a few rare exceptions) gets it. Turns out the case is not so simple in that Apple's claim was actually based on a 2006 contract it had with Proview to buy the iPad name from Proview. So the real question in the case appears to have been one of contract interpretation, not China trademark law.

Every few months, my firm gets a call from someone seeking either to sue someone in China for having "stolen" their trademark or seeking to buy it. I put quotes around the word "stolen" because if someone beats you by filing "your" name as a trademark in China, they have not stolen anything; they have merely beaten you to a name by being the first to file it.

When someone retains us to try to buy a name from a Chinese company that has registered it as a trademark in China, the first thing we do is try to learn more about the company and what it is actually doing with the trademark. That helps us develop our initial offering price. Then we have a Chinese person (NOT a lawyer) call to see about buying the trademark. We would never call the company ourselves because we figure that a foreigner calling drives up the price 100-fold. A Chinese lawyer would have a similar effect.

We are also increasingly getting retained by American companies seeking to register their competitors' trade names in China before their competitors catch on to the need to do so for themselves.

How can you stop a Chinese or a foreign company by beating you to "your" name in China? One simple way, register it before they do.

For more on China trademarks, check out the following:

If you are doing business in or with China you should give serious thought to registering your trademarks in China. In particular, you should consider a China trademark registration for your trade-name, your logo and your service marks. Brand identity is critical for success in China (as it is just about everywhere) and if you are going to protect your trademarks in China, you must register them. This is especially true in China where if you do not register your trademarks, someone is almost certain to try to appropriate them. If you have not taken the necessary steps to protect your brand, this theft will succeed.

This post explains why trademarks are so important for creating your brand in China. Your trademark is what conveys who you are.

No matter what the drink, if it has Coca Cola's name on it, you know that the odds are overwhelming that it will have been well made and be safe. Westin on a building tells you before you go in that it is a nice hotel. Think how damaging it would be to Coca Cola or to Westin if everybody could use those two names on their products, be they drinks or hotels. None of this is any different in China.

Unlike the United States, however, China employs a "first to file" system for trademark registration. This means that China does not recognize unregistered trade mark rights. So you must register your trademark to have any trademark protection. Without trademark protection, someone else can register "your" trademark and then prevent you from using it. This is true even if you are not conducting any sales in China. Even if all you are doing is manufacturing product in China, someone else can (and probably will) register "your" trademark and then stop you from exporting anything from China with that trademark on it unless you pay a licensing fee. This happens all the time and it mostly happens to companies from common law "first to use" trademark registration systems. It happens less often to European companies because they usually know better because they come from a first to file system.

All of this means that you should register your trademark or service mark before someone else beats you to it. In other words, you should register your trademark or your logo before you first start using it in China. If you know you will be using your trademark or logo in China, there is no benefit (other than cost delay) in waiting.

The first to file an application in China for a particular trademark gets priority to that trademark, but it can take years for the Chinese trademark office to actually issue your trademark. In the meantime, nobody can stop you from using the trademark for which you applied, but you cannot stop anyone else from using it either. So if you are planning to sell a trademarked product or service in China at some point in the future, there are real benefits to going ahead and registering for the trademark right away. That way you will either have it when you start selling or very soon thereafter.

Even if you are just manufacturing a product in China and are not selling it there, you must register your trademarks on that product before anyone else. This is because if someone beats you to "your" trademark, they will be able to stop you from using it in China at all and block your product (with the offending trademark) from leaving China's ports.

But what exactly should you trademark and how?

You should trademark anything that identifies your company or your brand or your product or your service that you can. If your company is Premier and your product is Alpha and your logo is a giant A and you sell a special sort of cloth headband, you should at least consider registering the following trademarks:

• The word "Premier" in Roman script
• The word "First" in Chinese characters
• The Mandarin word that sounds closest to "Premier"
• The logo

If you do not choose a name in Chinese and register it, the Chinese consumer will almost certainly choose a Chinese name for you and you may find you do not like that Chinese name one bit or that the trademark on it has already been taken.

There are essentially three methods for picking your Chinese name. You can translate your English or other foreign name directly into Chinese. Registering the word "first" in Chinese characters is an example of that. The disadvantage of a literal translation is that you will essentially have two different names for your same product or company and this can cause confusion in the market. The second option is to use a Chinese character name that sounds like your foreign name. If you go with a phonetic version of your foreign name, you must make sure that you know what the Chinese char a cters you are using actually mean in Mandarin and Cantonese. Otherwise, you might find yourself with a Chinese name that means something you really do not want to be saying. Oftentimes, the best solution is to choose a phonetic version of your name that also conveys something you wish to convey. Coca Cola is the classic example of this. Its name sounds like "Ke Kou Ke Le," which means "delicious" and "happy."

You will also need to consider in what category(s) to register whatever trademarks you deem necessary from the above. Returning to the example of the headband, there are at least two categories that make sense: hair accessories and clothing. If you register your trademarks in just one, you leave a massive opening for a competitor to step in and register the your same trademarks on the same product in the category you did not choose. If that happens, both of you will be able to sell the headband using the same trademarks. Not choosing all of the right categories for your trademarks can be as bad as not registering your trademarks at all.

By: Steve Dickinson

Registration of trademarks in China has become essential for doing business in China. We have long advocated prompt China trademark registration with our clients. For companies that manufacture and export from China, registration of the English language trademark is essential. For companies that sell products and services in China, registration of the existing English language marks and also the Chinese language marks for the product is essential.

When we first began to push our clients on trademark registration, we were met with a lot of skepticism. However, as we anticipated, the tide has turned. Recent reports from China claim that China now has the largest number of registrations in the world, with over 1.0 million applications submitted per year. It has now become almost impossible to do business in China without a full portfolio of registered English and Chinese language word marks and logos.

Unfortunately, this flood of applications has had the effect of making trademark registration in China a much more difficult process. When we first started doing trademark registrations in the early 2000 period, about all that was required was to simply submit the application. Virtually every application was approved. In fact, at that time, the Chinese authorities were often criticized for approving too many similar marks. In particular, English language marks were almost always approved except when the exact word was used in the same class.

These days, it has become far more common to receive a rejection. This is true for both English language and Chinese marks. It is no longer appropriate to just assume that every application will simply be approved. Careful evaluation of every mark is required. Since rejections have become common, it is now extremely risky to build business under a new mark or brand before receipt of approval from the trademark office. Since the trademark office is very slow in its decisions, often taking years to make a decision, this can pose extreme difficulty for companies attempting to penetrate the Chinese market.

There are several reasons for this change in the trademark environment in China:

1. The large number of applications means that there are simply fewer choices for available marks, particularly when the mark is a meaningful word.
2. The trademark office takes a mechanical approach in determining when there is a conflict. Where the same words appear, the trademark office normally ignores meaning and simply finds a conflict. Thus the trademark office does not allow for adding more words to allow for differentiation. If there is any chance of conflict, the trademark office will find it. For example, if someone already has registered the name "Ace" in a particular class, the trademark office will likely reject "Ace Tool and Die Makers and Fabricators" in that same class.
3. The trademark office also finds conflicts where words are similar but not identical. Since there are no clear rules on how much similarity is not acceptable, this makes the decisions of the trademark office difficult to predict. For example, registering "Alberta" in a class in which "Albert" has already been registered likely will be rejected.
4. The Chinese language presents additional difficulty. Though there are over 40,000 unique Chinese characters, only about 2,500 characters are in common use. It is therefore difficult to find a succession of characters that is any way unique. Since there is no way to alter spelling/pronunciation to produce a difference, the opportunity to find a unique combination in Chinese that is also intelligible is difficult.
5. The PRC trademark office has installed sophisticated search software. This search software fuzzy logic function is excellent and allows the trademark office to find more near matches than previously possible. These near matches then get rejected in situations that would never have been noticed in the past.
6. As a matter of bureaucratic reality, where there is a close call, it is much safer for the trademark office to reject than to approve. When a dispute arises, the Chinese courts have shown much more inclination to support trademark office rejections than to support approvals. Since the trademark office was severely criticized for allowing too many approvals in the past, the office has apparently decided to go as far as possible in the other direction to compensate.

None of the reasons for the difficulties with trademark registration are likely to change for the better in the near future. In fact, trademark registration applications will probably continue to increase, making the situation progressively worse, not better.

So what should be done? Since trademark registration is essential for China, foreign businesses must understand and adapt to the changed trademark environment. This requires at least the following:

1. Trademark registration should not be treated as a mechanical process. Careful planning is required. In particular, a preliminary search should be undertaken and time must be taken to do the search carefully and to deal with the results in a practical manner.
2. For word marks, the use of meaningful words should be avoided as much as possible. Coined words should be used whenever possible. Of course, a company that is using its existing U.S. name or mark often does not have a choice on the words that will be used. In such a case, the foreign party must understand that if a meaningful word is used there is a decent chance a conflict will be found and your trademark rejected. This is also true of trademarks of common names. So for example, if your company is called "David's ties" and someone has already registered David & Goliath in the same class, you will probably be rejected. We are finding that common name registrations are getting more and more difficult.
3. Even where the best search seems to show that there will not be a problem with registration, all registrants must understand that it has become difficult to predict how the trademark office will rule on any mark. This uncertainty means that it is not as good idea to build brand identity on a mark until after that mark has been formally approved by the trademark office.
4. There are numerous ways to deal with trademark conflicts. This usually involves negotiation for a license or related agreement with the holder of the mark that has priority. Most foreign companies have a well-deserved aversion to entering into such discussions with parties in China. However, such negotiation will be increasingly important in the new trademark environment.
5. Finally, some of the conflicting marks simply are not good marks. Some have never been used. Some have been filed with a bad intent. The Chinese trademark system has available a number of procedures for dealing with these bad marks. The procedures take time and money. However, they must be used in order to deal with these situations. Oftentimes, there simply is no other option.

Doing business in China is not for the faint of heart. Dealing with China's changing trademark environment is one of the many challenges that must be overcome to reach success in an ever changing China.

It is becoming increasingly easy to blame the "victim" of China business disasters. In my experience, when bad things happen to good people who do business in China, it is nearly always the "good" person's fault. Like many lawyers who work with China, I have a ready set of horror stories to illustrate this phenomenon:

1. A person "invested" $500,000 into a Chinese business because the owner was allegedly the son of a five-star general. A lawyer at my firm suggested that this investor instead go to Las Vegas and "put all the money on red." As the lawyer put it, the chances of the investor recovering his money in Vegas were much greater. Despite our warnings, this person proceeded to invest the $500,000 and, unsurprisingly, lost every bit of it. He then wanted our firm to sue the "son of the general" on a contingency fee basis. We declined.
2. Another "victim" bought a million-dollar condo in Shanghai under his girlfriend's name because he believed that foreigners were not allowed to own real property in China. His girlfriend then left him and claimed he had given her the condo as a gift. He wanted us to sue the girlfriend but my firm demurred. We just did not like a case in which our client would need to explain to a Chinese judge that he had put the condo in his girlfriend's name in order to circumvent what he believed was Chinese law. Had this foreigner done his research, he would have known that he could in fact have purchased the condo in his own name. His girlfriend had lied to him about Chinese real property ownership laws.
3. Countless people call my firm after having sent tens of thousands of dollars (sometimes hundreds of thousands) to China for a product that never arrived. Eventually the person and "company" to whom they sent the money disappear altogether. We have never taken one of these cases because of their utter futility.
4. A US company used its joint venture partner's local Chinese lawyer, who drafted up blatantly lopsided agreements. Pursuant to those agreements, the American company would permanently surrender its critical technology to the joint venture, without getting any real influence or control in it. This is an amalgamation of probably half a dozen poorly formed joint ventures for which my firm has been enlisted.

My colleagues and I can recount many more such tales with similar outcomes. This alarming pattern begs the question: What can a foreign investor do to protect its China investment? There are plenty of precautions one can and should take before jumping on the China investment bandwagon, such as the following:

• Investigate how other Chinese companies perceive the Chinese company in whom you are interested. Talk with the company's competitors, vendors, and customers. If the company has no such vendors or customers, that fact speaks for itself.
• In a country where managers often earn less than USD$1000 per month, it is neither unusual nor difficult for an unscrupulous company to buy someone's loyalty for the duration of a meeting or a phone call. Assume anyone with whom the Chinese company puts you in touch is in the pocket of the Chinese company. Use your own networks to research the company and industry.
• Ask yourself how the Chinese company might have staged everything you have seen, done, or been told by the Chinese company. Do you know for certain that the person with whom you just spoke is a customer of the Chinese company? Do you know for certain if the Chinese company really owns the factory you just toured? Does the Chinese company really make the products it claims it makes or did it just buy them from another factory? Does the person who is leading you around the site really own or even work for the company?
• If you come across something unusual that the Chinese company is doing, do not move forward until you are satisfied with its explanation. Do not do business with a Chinese company that is doing something that defies common sense. If the company is claiming to be a big seller of a particular product, but nobody who buys that product has ever heard of the company, ask why. If the company claims to be a thriving international company and yet uses a two person accounting firm, ask why. If the company claims it is registered somewhere but you cannot find the registration, ask why. Just because your Chinese partner and/or your Chinese partner's lawyer tell you "this is how things are in China" does not mean you have to believe them, and it certainly does not mean you have to abandon your common sense.
• Do not hire someone fresh to conduct your due diligence for you as that person may end up getting paid by the Chinese company to give you a whitewashed report. At least half the time when my law firm is brought into a fraud situation it is instantly apparent that a "trusted subordinate" was either incredibly stupid or, more likely, in on the fraud.
• It almost always pays to look closely at the company operations yourself. Go to the company's factory or office. Use your visit to determine how much material is moving into and out of the factory. Are the people in the office actually doing more than just acting as props? Ask the security guard how long the company has been in the building. It is important that you visit more than once and at least one of your visits be unannounced. We had one client who visited a Chinese factory a second time to find that the machinery from his first visit had vanished.
• There is probably no document that has not been faked thousands of times in China. I have seen fake bills of lading, fake bank statements, fake contracts, fake purchase orders, fake company registrations, fake IP registrations, even fake lawyers. If you are going to rely on paper, at least do more than just rely on the document itself. At minimum, check with the company or the governmental body that purportedly issued it..
• Put all of the documents you receive under a microscope. Even the most experienced scammers nearly always make some mistake in their fake documents. In my career, I have caught the following red flags in the paperwork:
  • A company that claimed to have a multi-million dollar account at a non-existent bank.
  • A company that claimed to have a thriving subsidiary in the Marshall Islands, yet always spelled the country as "Marshal Island." It had no such subsidiary.
  • A company that claimed to have a branch office in a particular city, but placed that city in the wrong province in its documents. It had no such branch office.
  • A company that claimed to be bringing in twice as much product as physically possible on a particular ship.
  • A company that claimed to have been shipping out product on a particular ship that did not exist during the first few years when the product was allegedly being shipped.
  • A company that claimed to have won an IP lawsuit in a country's supreme court (it even produced the court's decision), but there had never been such a case.

Before you do business with a Chinese company, try to get the company's official corporate records from the official Chinese government sources. Though doing this is neither inexpensive nor easy (and it has gotten considerably more difficult in just the last year), it can be incredibly enlightening in that it usually goes far beyond the information provided by the basic company search firms. The China company search firms typically provide only a basic list of information, such as the names and addresses of those involved with the company and its registered capital. The information from these search firms is also of dubious provenance. How did they get the information? Can you be sure they looked at the entire file? Since the files are only supposed to be open to lawyers, how did they obtain access? Because the previous year's documents may not be helpful, how recent are the documents they reviewed?

Most China business disasters can be avoided by giving your China investment its due diligence. Following this advice will not guarantee a wise investment, but it will certainly improve your odds.

What do you think?

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Chinese Spring Festival Gala usually had the highest TV ratings in the world, according to CCTV, its TV ratings in 2014 reached 30.94%. While in the US, Super Bowl also had pretty high TV ratings therefore Chinese called it "American Spring Festival Gala". 2014 Super Bowl hit a new record of 111.5 million viewers. Continue reading...

You may have missed the funeral, but China's new leadership has quietly buried the admonition of former leader Deng Xiaoping that as China rises in wealth and power it should maintain a low profile (known as taoguang yanghui). In its place, the new leadership is advancing a more proactive diplomacy in surrounding regions. President Xi Jinping is displaying self-confidence that seems to match the mood of the times in China, one of renewed nationalism and self-assertion. In most neighboring capitals this development will be viewed positively but warily; in Manila and Tokyo, less positively.

The issue is that China wants the benefits of a charm offensive with its neighbors, but it also wants to jealously guard its far-flung territorial claims. It cannot do both.

Beijing held a major conference on peripheral diplomacy on October 24 and 25. Xi made what was described as an "important speech," followed by remarks by Premier Li Keqiang and Beijing's top party and government foreign policy officials. This was shortly before China announced its intention to create a State Security Commission (also variously translated as National Security Council or National Security Commission) at the third plenum of the 18th Party Congress. Taken together, these actions portend a concerted activism that will deploy China's newly acquired wealth and influence to "maintain a stable peripheral environment."

Xi's speech catalogued the economic aid, trade, scientific and technological, financial, security, and public relations diplomacy tools for China's regional strategy. The official press releases did not mention sensitive issues such as territorial disputes or the soon-to-be-imposed air defense identification zone (ADIZ) over the East China Sea. According to people familiar with the details of the meeting, however, these issues were very much on the agenda.

As if to foreshadow the peripheral diplomacy conference with examples of what China is undertaking, Xi conducted a four-nation state visit to Central Asia in September. During his stop in Kazakhstan, he called for a "new silk road" with enhanced infrastructure and financing for energy, trade, telecommunications, and regional development throughout the region. The trip was positively reviewed.

Also before the conference, Xi and Li participated in the Asia-Pacific Economic Cooperation forum in Indonesia and the East Asia Summit in Brunei in October. While U.S. President Barack Obama stayed home to deal with a government shutdown, they conducted welcome visits to five Southeast Asian nations with promises of aid and trade.

One important announcement was the formation of an Association of Southeast Asian Nations (ASEAN) infrastructure bank. According to one official, this concept envisions using China's substantial foreign exchange holdings to finance ports, railways, highways, and other infrastructure to integrate China with Southeast Asian markets. Beijing intends to achieve regional buy-in with nominal contributions to the bank's capital from some of the members of ASEAN. The long-term economic and soft-power implications of this scheme, if carried through, appear substantial.

Differentiated Treatment of Governments and Publics

One result of the conference on peripheral diplomacy was an affirmation of the benefits of trying to win public support among the populations with whose governments China is having difficulties. After months of relentlessly negative press about Japan in Chinese media, in late October China hosted the ninth Beijing-Tokyo Forum, composed of former officials and private sector representatives from both countries. The media coverage of this relatively small event was uncharacteristically positive, and Japanese participants were able to contribute signed articles to Beijing's outlets.

Despite truly negative results for China in Japanese polls since the intensification of the dispute over the Senkaku/Diaoyu Islands and the announcement of the East China Sea ADIZ on November 23, Beijing reportedly is prepared to continue seeking to improve the attitudes of ordinary Japanese while freezing high-level official exchanges. Japanese trade and investment with China has remained surprisingly resilient. Beijing's goal is to isolate and press the government of Japanese Prime Minister Shinzo Abe to acknowledge the existence of a dispute over the islands.

Similarly, China is treating the Philippines in a differentiated fashion. President Benigno Aquino III was shut out of a China-hosted regional gathering because of ongoing disputes over offshore shoals and submerged rocks. Beijing is particularly irked by Manila's so-far-successful pursuit of a case against Chinese territorial claims with the UN's International Tribunal for the Law of the Sea.

Nonetheless, when Typhoon Haiyan (known as Typhoon Yolanda in the Philippines) devastated the southern Philippines, Beijing slowly but substantially assisted with humanitarian relief. China even dispatched its new naval hospital ship, the Peace Ark, to help treat those injured.

No Less Assertive About China's Claims

Another result of the burial of Deng's low-key approach to foreign affairs at the peripheral diplomacy conference was reinforcement of China's claims to disputed maritime territories. The conference reportedly gave final approval to the long-gestating objective of establishing the East China Sea ADIZ. It may have also envisioned ADIZs in the Yellow and South China Seas.

The notion first surfaced publicly in 2008 and gained support as Japan increasingly reported Chinese intrusions into its ADIZ, leading many Chinese to seek parity with Japan. Beijing did extensive research into the subject and discovered that the zones are not governed by international law and are well within China's rights to establish. When Japanese officials publicly discussed shooting down Chinese drones over the Senkaku/Diaoyu Islands, the impulse in China to move toward the declaration of a Chinese zone was strengthened.

Officials saw the zone as a means to increase leverage on Japan. If China were to declare a zone encompassing the disputed islands and overlapping Japan's ADIZ, it would presumably increase domestic and international pressure on Tokyo to negotiate rules of engagement to avoid incidents. This would give China the opportunity to insist as a precondition that Japan admit, as it has been unwilling to do, that a dispute exists over the sovereignty of the islands.

In light of the generally positive thrust of the policies intended with the peripheral diplomacy conference, the announcement of China's new ADIZ seemed especially clumsy and counterproductive with regard to China's neighbors. The People's Liberation Army has responsibility for the ADIZ and thus for its declaration. The declaration initially sounded like all dire warnings and no reassurance. The intensely negative reaction from the United States, South Korea, Japan, and Australia, and the nervous finger strumming of other neighbors, subsequently caused China to issue a series of reassuring clarifications.

This clumsiness, in contrast with the leadership's generally positive intent to promote a stable regional environment for China's continued development, may be due to the continuing effects of a military with scant diplomatic experience stepping into a diplomatic role. Former Chinese diplomats were quick to ask foreigners to tell the Chinese leadership that prior consultation on announcements such as that of the ADIZ should occur to avoid unnecessarily negative reactions. There is hope that China's new State Security Commission will bridge some of the gaps in policy execution, despite experience that dictates otherwise.

But it is equally plausible that China's leaders remain comfortable taking tough stances on issues involving sovereignty. Certainly, Xi's track record for the past year has emphasized vigorous defense of Chinese claims to disputed territories and advocated an increasingly capable military, especially in new areas of maritime activity. During a recent visit there, it was much easier to find ordinary Chinese taking pride in the fact that their government established China's growing influence through the declaration of the ADIZ than to locate critics.

Many Chinese are pleased that their government has taken a step to enhance and extend the reach of Chinese influence in a way that others cannot halt. This pride about the ADIZ announcement is consistent with the use of maritime administration vessels to assert Chinese presence in disputed waters, using ostensibly civilian means to circumvent direct military confrontation.

Policy Implications

China's adoption of a well-resourced agenda seeking better relations with its neighbors offers the kind of competition for influence that the U.S. government has repeatedly said it welcomes. China pursued such an agenda between 1998 and 2008 with considerable success, especially in Southeast Asia.

After the 2008 Olympics in Beijing and the global financial crisis, however, China became more outspoken and intolerant of its neighbors' claims. It embarked on an approach that would seize on actions by others involving disputes, such as Vietnam creating a municipal jurisdiction for its disputed South China Sea islands, and respond even more forcefully with actions of its own. This has triggered a series of quid pro quo chain reactions across the region.

In any event, whether China's neighbors are charmed or alarmed by Beijing's actions, their demand for an American counterweight will continue to grow. It is incumbent on the United States and China's neighbors to make the U.S. investment in their security rest within broader economic and diplomatic activities that will sustain the support of the American people. The Trans-Pacific Partnership negotiations symbolize this productive path to greater economic interdependence as part and parcel of a continuing U.S. role in the region.

Unlike in Southeast Asia, where distances and lower levels of military development tend to soften the effects of frictions with China for now, in Northeast Asia, all parties are better armed and in fairly close proximity, so their air forces and navies are well within range of each other. Moreover, the present leaders of China, Japan, and South Korea appear more willing to accept risks than their predecessors. Indeed, each capital seems to have calculated that a simmering level of tension suits its political needs. This can be the tinder for conflagrations that quickly get out of control despite intentions of restraint.

In this environment, one normally reaches for a cookbook of confidence-building mechanisms, such as hotlines, agreements on incidents at sea, and mid- and high-level diplomacy. This may be possible and probably is worth seeking between South Korea and China, where ADIZs overlap but territorial claims do not. In the South China Sea disputes, stepped-up efforts to achieve a workable code of conduct would be preferable to a new round of ADIZ announcements.

If China continues to condition such mechanisms with Japan on acknowledgement of a territorial dispute, then the political will to agree will not be found in Tokyo. The United States should continue to combine messages urging restraint by all parties with robust reaffirmation of the U.S.-Japan Treaty of Mutual Cooperation and Security.

A delicate balance must be struck between being unyielding to more unilateral efforts to change the status quo and getting trapped in escalatory behavior that might otherwise be avoided. This will require spokespeople for the Obama administration to speak with greater clarity and uniformity than they have at present on how the United States intends not to recognize China's new ADIZ. There is a need to reconcile State Department and White House statements with notices from the Federal Aviation Administration to civilian airlines that imply acceptance of the new ADIZ.

As it has done, the Obama administration should insist on freedom of navigation despite the declared ADIZ and on abiding by international established practices within the zones. It should also assert that an ADIZ conveys no implications regarding sovereignty.

And the United States and its security partners need to maintain or increase the pace of deployments and exercises within the first island chain to dilute the Chinese sense of having diminished American influence there. They should also compete vigorously with China's charm diplomacy in traditional and creative ways. There is considerable room for a range of multilateral initiatives on issues such as public health, the environment, education, and the sharing of fisheries as well as on more conventional security and diplomatic arrangements. The U.S. Congress should support and not impede the president's ability to carry out the nation's diplomacy.

In addition, the United States should sustain, deepen, and broaden its newly revived military-to-military interaction with China's armed forces. Congress should trust the U.S. military and retract the 2000 National Defense Authorization Act's constraints on that activity.

Finally, U.S. national security authorities should calmly seek opportunities to show China that the ADIZ surprise announcement was a costly mistake. Much as when North Korea launched a satellite and conducted its third nuclear-weapon test and the United States later announced an increase in anti-ballistic missile interceptor launchers in Alaska, Washington should patiently and nonprovocatively undermine the sense that American forces are being pushed out of China's near seas.

Beijing should be helped to understand that it is not a zero-sum game.

The video itself is really quite a masterpiece in my view, produced by a master of political warfare, PLA National Defense University Political Commissar Liu Yazhou. It details how America is waging a smokeless war of "political genetic modification" against China, utilizing the permeation (渗透) and "peaceful evolution" strategy that brought down the Soviet Union.

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