China WFOE formation and doing business in China

At the beginning of the US-China trade war we were one of the few voices saying this war would last a long time, with essentially no end in sight, and we took a lot of heat for that. More than seven months ago, in China the US and the New Normal, we essentially said that foreign companies needed to buckle up for a long ride because trade relations between the United States and China would get a lot worse and stay bad for a long long time. We also talked about how foreign companies were starting to look beyond China and we strongly encouraged they continue to do so. I only wish more had listened:

We are telling the truth about companies (not just American companies) looking to leave China because part of what we do is help companies legally fulfill their goals and their plans. My firm’s international lawyers help companies negotiate their exits from China and we help companies figure out where to go instead of or in addition to China. We also help companies looking to set up in other countries, do deals involving other countries, protect their IP in other countries, and draft necessary contracts in other countries. In the last few months our international lawyers have been being kept nearly as busy with countries like Vietnam, Cambodia, Indonesia, Thailand, Malaysia, Turkey, India and Pakistan as with China.

The above is but an introduction to what we see as China’s diminished future for foreign companies. Since pretty much the inception of the US-China trade war we have been saying that we do not see its end because we have always seen it as more than a trade war. At first, we saw the US tariffs as an effort by the United States to get China to “open up” and “act right” on things like the internet and IP. But because we did not see China changing on these things, we did not see the trade war ending.

Vice-President Pence’s speech on China earlier this week has only reinforced for me that the trade war between China and the US will not be ending any time soon, if ever. The New York Times has called that speech the Portent of a New Cold War between the United States and China and China’s own Global Times wrote an article entitled, Pence speech shows Washington’s tougher policy on China. Don’t blame us. We are just the messengers. Things are getting very tough between China and the United States right now and the trade war is just a symptom of that, not the disease.

The United States is aggressively and unabashedly doing what it can to isolate China and to remove it from the world of international trade. The new free trade agreement between the United States and Canada is further proof of this as it essentially blocks Canada and Mexico from engaging in free trade with China. See What Trump’s new trade pact signals about China. Word is that shutting out China is going to become a regular thing in all new U.S. trade agreements. See US Commerce’s Ross eyes anti-China ‘poison pill’ for new trade deals. Will the EU and Japan and Latin America play ball on this? I predict that most if not all of them will.

So yes, the above is why we will continue to write about what North American and Latin American and European and Australian businesses should be doing to deal with the new normal regarding China. We are writing these things because we value our credibility and because we presume our readers value our no-holds barred advice — threatening emails or not.

We eventually came to the view that companies were focusing too much on a US-China Trade deal as though that would, standing alone, lead to a return of the good times between China and the United States and (one day before President Trump’s May 5 “tariff tweet”) we wrote The US-China Trade War: Winter is Coming, in which we laid it on thick about how doing business with China is becoming bad for business:

Ask those who write about China about the hate mail they receive. I think of this blog as hewing pretty close to center when it comes to China and yet hardly a day goes by where someone doesn’t challenge us with a question like “how can you support a regime that does xyz horrible thing?” Many of these come as messages on our China Law Blog Facebook page and an increasing number of them include gruesome pictures of executions and slaughtering of dogs, etc., purportedly from China. I have no idea if those pictures really do come from China or when they were taken, but I would guess many businesses with close China connections receive similar messages. And I know from talking to reporters that a huge number of foreign businesses do not want their customers to know they are either in China or doing business with China. Why? Because doing business with China can be bad for doing business elsewhere and this is getting worse and will only continue to get worse. Yesterday the United States called out China for interning three million Muslims in concentration camps and I am quite certain this sort of calling out is will continue and even escalate after a trade war resolution.

When I was in student government back in my college days, the big issue was apartheid in South Africa and our student government voted to have the college divest from any of its investments in South Africa. That didn’t happen but many companies did pull out of South Africa so as to placate their customers/clients. We are seeing similar things happening with Saudi Arabia these days and there are China stirrings as well. I am NOT saying this will have a major impact on most companies, but if you pitch your company as socially conscious and you are not thinking of ending your dealings with China, you are behind the curve. What if you are just a run of the mill start-up or SME? What should you do? Should you flee China now to avoid social problems later? Almost certainly not. But if you can, let’s say, slowly and relatively painlessly move your supply chain elsewhere, you absolutely should seriously consider that. Everything being equal, would you not rather tell your customers (and even your own kids) that your company does business with Mexico or Thailand as opposed to China?

Just as many companies boast of how their products are organic or cruelty free, companies seem almost eager to let the world know that they have stopped manufacturing in China or are doing all they can to accomplish that. See the Wall Street Journal article, Trade Deal Alone Won’t Fix Strained U.S.-China Business Relations, whose theme is that the smart money wants to invest in companies that are out of China, getting out of China, or at minimum, have a plan to do so.

The post concluded by emphasizing that trade deal or no trade deal, US-China decoupling had begun and would only continue and now is the time to decide what to do about that:

How though should your business respond to all of this? To quote an old investment adage, “the trend is your friend,” and right now the trend is for the West and China to continue decoupling. This means the most important thing for your business is to be cognizant of this and to monitor it. We keep writing about this because we see it as likely to impact nearly all foreign companies that do business with China, even those from countries whose relations with China are much better than those between the United States and China. No matter in what country your company is based, if you do business with the United States — especially if you have your products made in China and then sell them to the United States — your business is at risk of becoming entangled by the decoupling.

If you want to see your company go into China or have its products made by China or increase its China presence, you should be prepared to explain to your company’s decision makers why you believe your business will not fall prey to US-China tensions. If you are having your products made in China, you almost certainly are already looking to reduce your China exposure, but in doing your cost benefit analysis for that, consider whether yours is the sort of business whose sales might increase merely by being able to tell its customers/consumers that your company does no business with China. And yes, this is going to sound self-serving (and it is, but it is also true), you need to more than ever make sure you are not doing anything that might make you an easy target of the Chinese government. In other words, make sure your company is in full compliance with China’s laws, particularly its tax, environmental, employment and bribery laws.

Weeks even before this “Winter is Coming” post, I was interviewed for an April 21, 2019, Wall Street Journal cover story, Trade Deal Alone Won’t Fix Strained U.S.-China Business Relations, in which I made clear my view that “There is no way any deal between China and the U.S. will cause everyone on both sides to say, ‘We were just kidding,’” said Dan Harris, managing partner at Harris Bricken, a law firm that specializes in investment with China. “The tariffs and the arrests and the threats and the heightened risk have impacted companies and that will not go away.”

We got a lot of heat for all of the above as well.

On the day of President Trump’s tariff tweet, I wrote The US-China Cold War Starts Now: What You Must do to Prepare, consisting mostly of my “initial” thoughts regarding what I am now calling a cold war:

My first thought based on the last few days is that this trade war is at its core a fight between the United States and China for who determines from where products are purchased. I am obviously not the first person to say this but I have to admit that this did not really hit home for me until yesterday One of my law firm’s Spain lawyers off-handedly mentioned something along these lines to me months ago, but it took me until now to realize how true it is. Both President Trump and President Xi are using their presidential powers to influence global buying decisions. Okay, I agree that when I say it like this it seems obvious, but I’m not so sure that it was or even is until you hear the following explanation. But hey, if I’m all wrong on this, just let me know — as the saying (sorta) goes: “there are no bad ideas here.”

Earlier this week I read how President Xi controls China’s economy. Well duh, right. No, I mean like really controls it, down to just about every nib. China wants to pay Canada back for Canada’s abiding by international law in arresting Huawei CFO Meng Wanzhou. See The Huawei Indictments are the New Normal. China chooses to do this by essentially telling its businesses that they better not buy any canola oil from Canada and, pretty much just like that, they don’t. This is on top of China already having taken hostage two Canadians and snap-deciding to sentence to execution another Canadian whose previous sentence was 15 years in prison. In other words, President Xi and those at the highest echelon of China’s government can snap their fingers and thereby create a new business reality.

Lacking in such nearly unmitigated power, but wanting that same power for himself, President Trump has been using tariffs to essentially accomplish the same thing. He has been raising tariffs against China and then negotiating with China and then threatening to raise tariffs against China and then raising tariffs against China, all the while pressuring various U.S. governmental bodies to increase their pressures against China products via non- tariff actions like anti-dumping and countervailing duties (AD/CVD). See Yet Another International Trade (AD/CVD) Petition Against China: This Time it’s Metal File Cabinets.

Make no mistake about it, President Trump is doing whatever he can to convince American companies — really any company from anywhere in the world that sells its products to the United States — to stop doing business with China. In ‘We’re freaked’: Trump startles US businesses with fresh tariff hike, CNN does a great job explaining (I think unintentionally) how this all works by focusing on how Trump’s last minute tariffs will harm U.S. businesses that did not prepare for this.

I then compared those who were ready for this cold war with those who were not:

Essentially, we have on the one hand businesses saying President Trump’s new round of 25% tariffs and his threatened (and likely to occur!) next round of 25% tariffs were a complete surprise on the one hand. And on the other hand, we have the Trump administration disputing this and accusing those who say this of having not made much of an effort to read the tea leaves regarding impending US tariffs against China.

I have to at least somewhat side with Lighthizer and Mnunchin on this because we have on this blog been relentlessly downbeat about US-China relations by basically screaming to anyone who will listen that you must start looking beyond China for your products. We have done this as recently as Sunday, in The US-China Trade War: Winter is Coming to more seven months ago in China, The United States and the New Normal.

So to at least some extent, those who just assumed that China-US relations would soon return to how they were before the United States initiated its first round of tariffs were either not reading enough or were too much ignoring or just misinterpreting what they did read. Nonetheless, I completely get where these complaining companies are coming from because most of my own law firm’s clients that were having their products made in China last year are still having their products made in China right now. In large part this is because leaving China is neither fast nor easy.

Some of our clients have left China entirely, moving their production to Thailand, the Philippines, Mexico, Indonesia, Vietnam, India, Sri Lanka, and the Ukraine, among others. Some of our clients have diversified their supply chain away from China, while remaining in China. Others are working on exiting China or diversifying away from China. Many though — and for various reasons — feel they have no choice but to remain in China for the short term and even beyond. So yes, there are some companies that should have left China 6-12 months ago but didn’t, but there are more companies that simply could not leave China fast enough to avoid this next round of tariffs.

In September 2018, in How to Leave China and Survive, we wrote about how difficult it is to cease having your products manufactured in China and how that can be done in way that minimizes myriad potential problems. I would urge anyone looking to move away from China to read that carefully before instituting any actions that might lead anyone in China to think you might be leaving.

But if you are going to leave China, where should you go and how even should you go about determining this? And what can you do to try to secure an exemption from these new tariffs? In China/U.S. Tariffs and How to Fight Back, one of our international trade lawyers explained how to try to secure an exemption to previous tariffs and much of what was written there will apply to this new round of tariffs as well.

Yet even in this post in which we decreed the dispute between China and the United States to be a cold war and even as we highlighted the need for foreign companies to reduce their China exposure, we noted how for some companies, now is the time to actually go into China:

And just as we are seeing so many of our manufacturing clients beating down the doors to get out of China, our China WFOE formation work is at its highest level (by far) in the history of our firm. In other words, we are on the one hand working to get many clients out of China while at the same time working to get many of our clients more deeply embedded into China with their own Chinese companies. Who are the companies going in? Mostly tech companies and companies that sell their products and services to China. Most of these companies either do not care much about the tariffs or are going into China because of the tariffs. For example, one company that does a lot of manufacturing in China is going into China to start selling its made in China products there, while at the same time looking to have its products made outside China for selling to the United States. As I am always saying, lawyers thrive on change, whether the change is for the better or for the worse.

Then earlier this week — in the midst of ever increasing gloom and doom regarding trade — we wrote a post, Why NOW Is a Good Time to Double Down on Doing Business in China, explaining why it is that our China WFOE lawyers have literally never been busier and explaining in considerable detail why now is a good time for many sorts of companies to form a China WFOE to set up shop in China to better conduct business there:

Relations between China and the West are declining and yet Western companies are moving as fast as they can to go into China? What is up with that? I will tell you….

Our client companies that are going into China know what is happening with China and in China and those things are actually fueling their decisions  to go into China and to do so quickly. Those same things are fueling decisions by other clients to increase their footprint in China. These companies are telling us that they are doing so much business with China or will be doing so much business with China that it makes no sense for them to just walk away. That being the case, they are rightly concerned that if the only business they do with China comes from their corporate entities outside China, they are at extreme risk of getting cut off by changing tariffs and/or Changing trade relations. But if they are actually doing business in China through their own Chinese company (such as WFOE or a Joint Venture), they will be much better protected against the vicissitudes of international trade. And they are correct.

Way back in October — when many still believed China trade would quickly revert back to the way it had always been — we did a post, Six Key China Business and Law Trends setting out what we were seeing then, which is pretty much exactly what we are seeing now:

Our China lawyers had a team meeting yesterday and as is so often the case at such meetings, much of the meeting involved our talking about what we have been seeing lately. We mostly focused on the following trends:

  1. Six months ago, we rarely worked with our firm’s international trade lawyers. Sure, we would occasionally call one of them in to help with a sticky customs issue or a client concerned about getting hit with antidumping or countervailing duties, but these days we find ourselves working with them constantly. Companies that are getting hit or will soon be hit with having to pay 25% tariffs are looking for help in figuring out how to have their Made in China products made elsewhere so that they can legally avoid having to pay the tariffs. See China Tariffs and What to do Now, Part 1 and China Tariffs and What to do Now, Part 2.
  2. Six months ago, about 90% of the international contracts we drafted involved China or the EU. That number is now nearing 60% as our existing and new clients are diversifying outside China.
  3. International litigation is on the rise. We are reading about this and we are seeing it. This is happening because of the uncertainty and the disruptions stemming from the tariffs. With disruptions and uncertainty comes disputes.
  4. China is more open to foreign businesses than it has been in years. Forming a WFOE is a bit faster, cheaper and easier than it was just a few years ago, especially if your WFOE will be operating fully legally. Check out The NEW Steps for Forming a China WFOE.
  5. Chinese factories are copying and selling their foreign customers’ products faster than ever before. Almost every week we hear of a Chinese factory that sold its foreign customer’s product before or right after shipping out the foreign customer’s first order. The tariffs are causing Chinese factories to question the viability of a long-term relationship with their foreign buyers and they are simply calculating that they can make more by selling their customers’ products online themselves. In the past, our lawyers did not push back when start-up companies wanted to test their product in the marketplace before spending for a contract to protect against their Chinese manufacturer competing with them. Now though we make very clear that this a very bad idea because by the time market strength has been determined, there may no longer be a product to sell. See China Trademark Theft. It’s Baaaaaack in a Big Way, China and the First to Market Fallacy, and Protecting Your Product From China: The 101.
  6. Following the law makes sense if you are going to be doing business in China. The number of companies coming to us with big China legal problems has gone way down but the number of companies coming to us to proactively present big and small China legal problems has gone way up. This is a good thing because it means foreign companies have come to realize China has gotten both serious and effective at enforcing its laws as against foreigners. See Doing Business in China Without a WFOE: Will the Defendant Please Rise for a good example of where China has really cracked down against foreign companies and see China Employer Audits: The FAQs for a good example of the sort of thing foreign companies are doing in China to avoid future legal problems

As it becomes clearer and clearer that trade with China has permanently changed, what China does with foreign businesses in China is going to become more and more key. China can essentially go one of three ways on this:

  1. It can turn even more inward and make it as tough as possible on foreign companies. It can enact new laws to accomplish this. This would hurt China’s economy.
  2. It can stay the same, with the same being fairly encouraging of foreign direct investment by foreign companies that follow Chinese law.
  3. It can open up further to foreign investment to benefit its economy and to garner allies for reinvigorating China’s trade relations with the West

So far, China has consistently taken the third way and gone out of its way to welcome Western businesses into China and assure them of their economic security. Indeed, China has enacted laws designed to make it easier for foreign companies to do business in China.

And as so many of our clients that are going into China (via WFOEs or Joint Ventures) or increasing their China footprint by adding branch offices and employees there, “being in China is good for our China business.” Chinese consumers and Chinese companies prefer buying from foreign companies that have boots on the ground in China. This has always been true and it very likely always will be true. Foreign companies with boots on the ground in China are perceived as being more committed to China (because they are) and as being better able to stand behind their products and/or services (because they are). Or as one of our clients told us, they believe that by making a strong commitment to bolstering their China presence now, they will be greatly rewarded by their customers who will view them differently from their competitors that are either not there at all or are looking to leave or to reduce their presence there.

In the final analysis, what makes sense for your business will depend on your business and your industry but for many businesses now is indeed the time to fish or cut bait with China and for many businesses, doubling down on China is the way to go.

Well guess what? It looks like those foreign companies that have gone into China are mostly thriving. The Financial Times did a story this week on how how foreign companies in China are generally thriving despite China’s economic slowdown and they have statistics to back this up:

Foreign companies operating or selling in China bucked the country’s slowdown trend last year, even as the world’s second-largest economy appears to have decelerated more than official figures suggest. China’s biggest economic slowdown in three decades is provoking angst among companies that have become used to its booming economic expansion. Overall, the revenues of 2,891 foreign non-financial companies grew 19.8 per cent last year, compared with 13.9 per cent in 2017, according to data from financial intelligence provider FactSet.

The rest of the article — which is mostly a very long introduction to a four part series on China’s economy — mostly just discusses how much worse China’s economy is than its official economic statistics would indicate. But for us the big takeaway is that despite China’s declining relationship with the United States and the rest of the world and despite China’s declining economy, business for foreign companies in China is booming. The reasons we list above for why now is actually a good time for foreign companies to go into China are likely the reasons why business is so good for foreign companies that are already there.

What are you seeing of foreign businesses in China these days?

UPDATE: This just in. President Trump has signed an executive order declaring a national emergency over threats against U.S. technology. Following this order, the U.S. Department of Commerce announced U.S. companies cannot sell or transfer technology to Huawei Technologies and its affiliates without a license to do so from the Bureau of Industry and Security. It is widely believed this will greatly reduce or even eliminate U.S. company purchases from Huawei and it may also make it more difficult for foreign companies with U.S. connections to buy from Huawei as well. I have added this to this post because it so well illustrates why we are of the view that a “trade deal” between China and the United States will do little if anything at all to stem the slide in US-China trade relations. For more on this breaking news, go here.

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Dan Harris

I am a founder of Harris Bricken, an international law firm with lawyers in Los Angeles, Portland, San Francisco, Seattle, China and Spain.

I mostly represent companies doing business in emerging market countries. It has taken me many years to build my network and it takes constant communication and travel to maintain it. My work has been as varied as securing the release of two improperly held helicopters in Papua New Guinea, setting up a legal framework to move slag from Canada to Poland’s interior, overseeing hundreds of litigation and arbitration matters in Korea, helping someone avoid terrorism charges in Japan, and seizing fish product in China to collect on a debt.

I was named as one of only three Washington State Amazing Lawyers in International Law, I am AV rated by Martindale-Hubbell Law Directory (its highest rating), I am rated 10.0 by AVVO.com (its highest rating), and I am a SuperLawyer.

I am a frequent writer and public speaker on doing business in Asia and I constantly travel between the United States and Asia. I most commonly speak on China law issues and I am the lead writer of the award winning China Law Blog (www.chinalawblog.com). Forbes Magazine, Fortune Magazine, the Wall Street Journal, Investors Business Daily, Business Week, The National Law Journal, The Washington Post, The ABA Journal, The Economist, Newsweek, NPR, The New York Times and Inside Counsel have all interviewed me regarding various aspects of my international law practice.

I am licensed in Washington, Illinois, and Alaska.

In tandem with the international law team at my firm, I focus on setting up/registering companies overseas (via WFOEs, Rep Offices or Joint Ventures), drafting international contracts (NDAs, OEM Agreements, licensing, distribution, etc.), protecting IP (trademarks, trade secrets, copyrights and patents), and overseeing M&A transactions.