One-off Jump of the RMB?

June 11th, 2008

Although building domestic imbalances in China –maybe partially as a result of the country’s undervalued currency – have promoted speculation that a one-off revaluation may be in the offering, most people predict Status Quo will remain.

Stability remains the watchword for the Chinese government.  Chinese Premier Wenjia bao was recently quoted in the Financial Times as saying that China must “maintain a certain degree of fast economic growth to provide enough jobs,”  indicating that the country’s elite may sacrifice economic output to bring down inflation because of the possible risk of increasing the jobless rate. This suggests that drastic action is unlikely to be taken any time soon. Fan Gang, an advisor to the center bank of China said recently in Beijing, “in order to reduce the inflow of speculative money and prevent speculation on a bigger magnitude, China is in greater need of a relatively stable exchange rate policy,” 

In a recent report Jonathan Anderson of UBS explains why he doesn’t think China will adjust the currency via a large one-off revaluation.  I thought his ideas were very interesting:

“1. It would hurt the wrong people… The problem behind the trade surplus is not overly competitive exports per se … but rather imports, or more specifically the sharp drop in import demand over the last few years as rising domestic heavy industrial capacity has taken over market share at home and in some cases (e.g., steel) pushed surplus production abroad.

In this environment, the optimal solution for the Chinese authorities is to (i) raise costs for overinvested heavy industrial sectors in order to force out marginal players and rekindle import spending, without (ii) overly penalizing traditional labor-intensive export manufacturers, who are the single largest employer of poor rural migrants.  What’s the best way to achieve these aims? The short answer is to let the renminbi strengthen steadily, but not in big discrete jumps.

2. The timing is getting worse. Even if the authorities had been thinking about a one-off move before, it’s unlikely they would still be considering it now on the heels of the painful weather-related disruptions in transport and power supply in January and February. In short, this is not an environment where it would make sense to try an abrupt change of tack on currency policy.

3. …The central bank still has a long way to go before it runs out of options for managing a more gradual scenario…Equally important, FX reserve pressures have been fading over the past six months following the “scare” in the first half of 2007, when inflows jumped sharply. The trade surplus was essentially flat through all of last year on a seasonally adjusted basis and could actually begin to decline in 2008, and as we show below, the strong portfolio capital inflows of a few quarters ago seem to be drying up as domestic equity and property markets fall.

4. No need for emergency inflation fighting. One of the most common arguments in favor of a large up-front revaluation is that the China now needs emergency measures to fight inflation. But this argument makes no sense to us, for the following two reasons. First, as we’ve stressed continually over the past months, there’s no indication whatsoever from the data that current headline inflationary pressures are structural in nature. …As of end-December “core” non-food CPI is perfectly stable; all of the increase in headline CPI in 2007 has come from food, and nearly all of the pressures within food have come from meat and eggs prices alone. This is hardly a picture of widespread, spiralling inflation (the picture may change temporarily in January and February as weather-related shortages lead to price spikes, but this effect should soon fade as well).

And second, there’s no rationale behind expectations that renminbi strengthening would help moderate domestic food price increases – for the simple reason that is not a significant importer of food.

5. Fading speculation worries. Another very common argument is that can’t successfully pursue a gradual renminbi strategy, since letting the currency appreciate by 8% to 10% per year would bring in a flood of speculative capital and overwhelm the PBC’s ability to control the money supply. And in the first half of 2007, it seemed that this was precisely the case: “hot” money was visibly returning to the mainland once again in large amounts, and the central bank was forced to slow down the pace of exchange rate appreciation so as not to encourage further speculation.”

However, Michael Pettis, a professor at Peking University, disagreed with Anderson.  In Pettis’s opinion, there are such serious problems with the rapid appreciation option by a process of elimination China is left with a one-off jump. He said “a one-off revaluation is a bad idea, but everything else is worse.”

Anderson or Pettis can be right or wrong.  But no matter what, with the 2008 Beijing Olympic Games thrusting China into the spotlight, stability and credibility are even more important than normal, and as such, Chinese authorities are expected to hold off on any drastic policy changes until they become absolutely necessary.

 
By Julia Zhu

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Winds Are Beginning to Change Directions

June 3rd, 2008

A very famous statement made by Mr. Deng, Xiao Pin, a prominent Chinese politician and reformer, and the late leader of the Communist Party of China,  that “no matter it is a black cat or a white cat, as long it can catch mice,  it is a good cat” is not true anymore in China today’s foreign investment climate.  Not all foreign money is welcome to China as it used to be. 

I elaborated on this point in my presentation made to the Beverly Hills Bar Association a few weeks ago. My topic was foreign investment in China including intellectual property protection.  

I suggested foreign investors watch certain issues in China in 2008 before they set foot on the Chinese market.   Growing signs of nationalism is one of top concerns of foreign investors in China.   Major government policies have placed the emphasis on “quality”, not “quantity” of foreign investment, and on making best efforts to use foreign investment to boost domestic innovation.  The Antimonopoly Law contains provisions that some MAs can be reviewed and killed out of national security concerns. 

Product safety will be a major issue too.   Food and product safety will remain high on the Chinese government’s agenda this year.  Foreign investors should expect new regulations and stepped-up supervision and inspections made by government agencies. 

Most noticeably, China has made several new laws/regulations last year which would have tremendous effect on foreign investment.  Enterprise Income Tax Law, Labor Contract Law, Antimonopoly Law, and Catalogue Guiding Foreign Investment in Industry are four good examples.  As you can see from the new catalogue, the Chinese government changed its’ attitude 180 degree toward certain foreign investments.  For instance, investment projects which export 100% of their products and industries where China has mastered (e.g. clothes, furniture, toys, etc), both of which were highly encouraged by the Chinese government, are now put under the restricted category in the new catalogue. 

Another side of coin is China has also provided foreign investment opportunities in certain areas such as high-end services like progress outsourcing and logistics, new and high technology, environmental and energy-saving projects,  healthcare service, pharmaceutical, and medical device sectors.

The long and the short of it is that it has to be a good cat to be a good cat.

For more information about my presentation, please feel free to contact me at jzhu@usachinalaw.com

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WATCHING THE OLYMPIC TORCH CEREMONY

April 22nd, 2008


On April 9, 2008, I went to San Francisco to see the Olympic torch passed. As a Chinese citizen living in the U.S. I was excited and proud that China is hosting the Olympic Games this year and wanted to show my support.

When I arrived at the AT&T Center at about 9 o’clock Wednesday morning, I was very touched to see hundreds of pro-China observers already waiting there. Most of them were older generation Chinese-Americans, some dressed up in traditional Chinese dancing dresses with ribbons and musical instruments, ready to perform traditional dancing when the Torch appeared. Many of them came from the East Coast to see the event. Unfortunately, because of the chaos caused by the protesters, we weren’t able to see the actual torch.

While walking towards the Golden Gate Bridge, groups of very young American protesters (all in their late teens or early twenties) who were parading on the street started shouting at me and my boyfriend. As I passed by a seemingly Tibetan woman standing in a smaller protest group on the sidewalk, she pointed at me and yelled, “China woman! Liar! Killer!” which then caused all the Americans around her to start yelling at me. I was totally shocked; I’ve never killed anyone and never would! So I tried reasoning with a couple of protesters on the street who seemed less dangerous and violent. Even though all of them repeatedly told me that China is killing its people everyday, none of them had actually been to China or Tibet and all that they knew about China came from the media.

One protester even told me that the reason he couldn’t visit Tibet was that it had been “under absolute separation by the Chinese government for the past 50 years”. I told him my previous boss had visited Tibet with his American family about a year ago with no problems and that one of my Los Angeles friends just came back from Tibet a couple months ago. They had showed me their pictures from their trip and everything seemed happy and peaceful. From what I know, people in Tibet were doing fine before the riot on March 15. The fact that I had lived in China for 21 years with friends and family members still happily residing in China, held no weight with him. Obviously, what he had learned from the media was more convincing to him than the experience of an actual Chinese person. At the end of our encounter, I sincerely requested that he visit China, to see the country with his own eyes.

There were a lot of reporters there but their cameras only followed the protesters. Some supporters tried to talk to the media but the reporters just shut down their cameras and walked away. A middle-aged ethnic Chinese lady approached a reporter and said, “You need to listen to both sides.” The reporter smiled and said, “Of course”. Then he waived at his camera man and they both walked straightly by us. When I read the news on the Internet after the trip, I even found a report claiming that the torch supporters were paid to be there. I was there and I was never paid, neither was the disappointed older people and the hundreds of supporters that I had met. In addition, the warm welcome that the torch bearer received in Buenos Aires, Dar es Salaam, Muscat, and Islamabad were not reported by the Western media either.

The Olympic Games is supposed to bring together the whole world, people who do not necessarily, and should not have to, share the same political opinions. Some countries participating in the Olympics do not even talk to each other politically. This is the beauty of the Olympics—an event for the peoples from different nations to come together, to join and compete and have fun. Can we please just have one peaceful event to enjoy and keep it from being a political leverage? And, if you really care about China, and about the Chinese people, please come to China and see us with your own eyes.

Jackie Zhao

Alpha Leader Group U.S.

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Changes in China That You Can See

November 13th, 2007

09/20/2007
It used to be that when Chinese students went abroad to study, they did not return. That seems to be changing. More and more Chinese born students are returning to China to live permanently. I can think of ten of my classmates who have returned home after prolonged study in the U.S. and Western Europe.
Eight years ago, when I left China to study in the United States, if you’d asked me, “do you think its a good idea for foreigners to live or work in China?” I would reply that “you are crazy”. After returning to China last month the changes on the streets of Guangzhou were so pronounced it seemed I was in a western country. Only the Chinese characters on the signs assured me I was really in China!
Food from every country and nationality is now available and is said to be authentically prepared. I saw many American, Australian, Middle Eastern, African, Korean and Malaysian restaurants. You can easily find Florida Orange Juice, Washington apples, Japanese imported salmon and Australian milk in the supermarkets. Tourists and expats who don’t care for Chinese food can now easily survive in China.
Before I left, I had to carry cash in RMB to go shopping, watch a movie, or to eat at a restaurant. That is no longer the case. More and more shops take credit cards. In fact you don’t need to pay cash when you take a taxi in Shanghai.
The streets in the main cities in China are becoming more and more crowded – more people drive their own cars to work or for personal trips. The only place I saw people riding bicycles was in Guangzhou.
When I chatted with my nieces and nephews who are much younger than me, they all feel their future is promising and there is nothing to worry about. My relatives speak about a “positive confidence level” which didn’t exist when I left China.

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Chinese Defense Lawyers’ Life Becomes Easier – Amendments to Law on Lawyers

October 24th, 2007

China’s top legislature is planning to adopt a draft amendment to the “Law on Lawyers” which will make it easier for defense lawyers to meet criminal suspects and obtain evidence.
Chinese lawyers have long complained of difficulties in meeting criminal suspects and having access to files and evidence when defending criminal cases.
In the proposed amendment, the provision allowing a defense lawyer to meet a criminal suspect without approval from a judicial department is the most noteworthy. Additionally, defense attorneys and criminal suspects will not be monitored when they have a conversation. Defense lawyers are entitled to look up all files and materials relating to the case and have the right to collect evidence.
The proposed change to defense lawyers’ rights under the amendment is in conflict with the provisions of the Criminal Procedure Law, which explicitly requires that a defense lawyer must have approval from the judicial department before meeting a criminal suspect.
The criminal Procedural Law is said to be under revision and the revised version is expected to conform with the draft amendment to the Law on Lawyers.
The proposed amendment suggests that the presumption of innocence is becoming a dominant principle in dealing with criminal cases, and the protection of the rights of criminal suspects accepted as a matter of procedural justice.

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Mistake #8- Local Professionals

July 22nd, 2007

Because of China’s outdated accounting system, bureaucratic controls, lack of legal transparency and its ever changing laws and national and local regulations, sound professional advice is an essential prerequisite to establishing a business presence in China.

Your network of professionals must be identified and selected before you consider establishing your business in China.

A key preliminary decision is how to select your professional team in China. It is easy to hire a local professional - China now offers a wider range of professional services than ever before: accountants, lawyers, business entry and HR consultants, as well as sales, marketing and public relation professionals.

However, the China professional services market is fraught with potential pitfalls and problems.

While fraud is as common in China as it is anywhere else, you have to be aware of a few local characteristics that may complicate your business in China, such as the low level of IP consciousness among Chinese citizens and employees.

Incompetence and inexperience are just as dangerous to you as dishonesty. Providing professional services for foreign investors is a booming industry in China. That means it looks like easy money to lots of young inexperienced university graduates. You need help to find the right mix of education and experience in your professional advisors.

Getting what you ask for is a huge challenge in China. Don’t assume anyone will tell you if your goals or standards are not possible. Many inexperienced local professionals will not understand your quality requirements and will provide services they feel are “just as good”.

You and your local professionals may have different agendas. For example, many business entry consultants are really nothing more than shills for their friends and “connections” with expensive services and business solutions to sell you. Your business entry consultant needs to provide you with value-added advice and planning assistance.

You should only hire local professionals if they have the “connections” you need and the soft-skills you want. However, before you use local professional services, we recommend you carefully check every representation made by them to you.

International experience is absolutely essential. Make sure the local professionals you are speaking with have the international experience, not the firm he works or previously worked for. Be specific in your questions and make sure you are satisfied with and understand each answer.

Traditional Chinese businesspeople don’t see any virtue in specialization. Many professionals in China won’t say “no” to an opportunity, regardless of their ability to competently do the required work. Instead, they’ll learn by doing based on their theory, whatever mistakes they make will help them in the future. You, however, will pay the price for their education.

Judge a professional by his proposed solution to your problem. Make sure they are providing value-added answers. Find a specialist who has handled the specific transaction for which you need professional assistance.

Be very clear who is doing the work. Don’t be afraid to ask “naive” questions like “do you have the staff who can do what you say they can?”

When dealing with local professionals, references are extremely important. Make sure you are getting current, actual references from clients who have used the professionals to provide them the same professional services you require. Find out who the partners in the professional firm are and what they’ll be doing for you. Find out the transactions that were completed by the firm not just people the partners have worked with on a previous transaction. Call past clients and make sure that the firm actually worked on the specific transactions and provided the professional services they say they provided to the references.

Once you have identified and selected your team of local professionals, you cannot just sit back and let them take care of your business. Operating a business in China requires much more rigorous management than is required in North America.

One basic approach to managing your team of qualified local professionals in China is to hire a lead consultant to act as the project manager for the team. An expatriate operated consulting firm catering to the international market is usually the best choice for this job. By directly working with them, you will get the skills, talent, and communication you receive in North America. They usually understand China in the way you need to understand China from an international business perspective. They have proven experience in China and market-specific knowledge. They definitely understand your requirements, and will manage your team of professionals and your business in a way that makes sense to you, at a level of quality you are accustomed to.

Take-away lesson: local professionals in China can be helpful, but you need foreign-run consultants to help you locate and manage those qualified local professionals.

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Mistake #7- Visit China

July 18th, 2007

There is no excuse for being unprepared to establish a business presence in China today.

It is important to take the time necessary to build relationships with your potential business partners and to conduct due diligence in China. If you feel that you are too busy to do this, then you are probably too busy to consider establishing a business presence in China.

Doing business in or with China can be as tricky as it is rewarding. Before you begin your long journey to the China market, you should perform due diligence regarding every aspect of your business, from potential partners, suppliers and employees to the area and facility in which you plan to locate your business.

It is quite easy in China for potential partners to appear more experienced or “connected†than they are in fact and to exaggerate the benefits of doing business with them. You cannot rely on mere representations. You need to verify your potential partners are who they say they are: they possess the qualifications and experience they claim; and the benefits of doing business with them are as represented.

Good independent professionals, such as lawyers and accountants can help you perform the due diligence you need to do before you get too far into your China planning. However, once things appear to be as represented, it is time to visit China.

Why is a visit so important? In China, face-to-face communication is irreplaceable. Visiting China for face-to-face meetings with local business partners and potential customers is necessary to gain both market knowledge and your perspective on doing business in China. It can also start the process of developing key personal “Guanxi” relationships and trust.

Building trust in China involves lengthy discussions in person on non-business topics and shared meals in restaurants. In China, business-related discussions start only once your counterpart has become comfortable with you as a person. If you want to do business in China, you better have plenty of time. Believe it or not, literally millions of dollars have been “left on the table” because Americans were too impatient to close the deal. Do not rush into or out of a deal.

Visits to China are also necessary to understand your potential business partner’s operations and to determine if you will be comfortable working with your business partner.

When visiting your potential business partner, one of the most important things to evaluate is the quality of the company’s key people. Intangibles such as trustworthiness and competence are difficult to judge, but they are the key to the success of your business in China.

Company ownership is an issue to address during your first visit. While many state owned enterprises have been privatized or turned into joint ventures with foreign companies, ownership details are often hazy. A private enterprise is not inherently riskier than a state-owned or joint venture, but a small private entity will have more difficulty acquiring the capital necessary to expand its operations to meet demand. A visit is important to get a sense of your potential partner’s financial background and status.

Quality control is a crucial detail to discuss during your visit to a factory. You can get to know the factory’s quality control system with the help from the director of Quality Control. However, you need to physically inspect their assembly lines or work shops to really understand the factory’s quality control system.

It is also important to determine whether the factory operates in a “cleanroom” environment. Due diligence conducted before the visit may provide this information, but a physical inspection of the factory will confirm your potential business partner’s representations.

Take-away lessons: (1) do not rush into or out of a deal; (2) visit China before you go too far with your plan to establish your business presence in China.

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Mistake #6- Learn the Market

May 7th, 2007

China’s language, culture, and distance all make it seem very alien to most people. Many people have also heard that the country is an extremely difficult place in which to do business.

The simple response to these concerns is you should never make generalizations about nor leap to conclusions regarding China. More often than not it is as easy to conduct business in China as it is anywhere else. If you invest time and effort to learn the culture and language, you will be rewarded many times over.

The most important prerequisite to doing business in China is to be prepared. Read up on the country. Spend time conducting market research. Know who you are meeting. Take an interest in the cultural and social factors that influence business decisions in China.

Most Chinese people attach great importance to cultivating, maintaining, and developing connections (guanxi) and are highly sensitive to face (mianzi) These social values, which are the keys for understanding Chinese social behavioral patterns and business dynamics, are shared by Chinese living not only in the PRC but also by those living in Taiwan, Hong Kong and in overseas Chinese societies all over the world.

However, it is essential for you to understand the geographic and ethnic diversity in China in order to avoid creating or strengthening the stereotypes of China. It is important to understand that not all Chinese are alike or eat the same food or talk the same way, or even think the same. From Harbin in China’s Northeast, to subtropical Haikou on Hainan Island in the South China Sea, China encompasses diverse topographies, climates, cultures, and people. Each region therefore has its own business culture and etiquette, consumer preferences and business needs. Throughout history, Chinese businesspeople from different regions have exhibited distinct characteristics. These distinctions have reemerged or evolved into features that have differentiated one region’s businesspeople from another’s and even contributed to the formation of unique competitive advantages.

Furthermore, although China has a strong central government and laws and regulations are similar throughout China, there exist significant differences in local government effectiveness. Some local governments are more efficient, disciplined, transparent, accountable, and have a rule-based mentality. Also, local governments are aggressively competing for foreign investment to generate local jobs and tax revenue. They offer different benefits regarding tax abatement, and use costs, infrastructure support, and so on. So you may also wish to check the reputation of, and the proffered benefits provided by, local governments before committing to a particular locale.

It is interesting that many of the teachings of how to do business in/with China tend to start or end up with listing out some stereotyped cultural tips and types, and our response towards it is that it is really inadequate. We do believe that cultural awareness contributes to business success. The stereotyped cultural tips, however, could be very misleading when delivered in an over-generalized approach or taken with an over-simplified manner without better and live understanding of the specific situation of China. The speed of change, the scope of the land, the complexity of systems, the span of history, the diversity of local cultures, the varied levels of educational development in different localities, and the gaps in economic development among areas would all affect business developments and successes, either domestic or international.

Take-away lessons: (1) invest some time and effort to learn the market in China, but do not make generalizations about China; (2) understand businesspeople from different regions of China may do business very differently; (3) do not rely on cultural tips too much: (4) cultural knowledge will not guarantee a success, but rather, it is a plus.

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Mistake #4- Intellectual Property Protection

May 7th, 2007

It is no secret that piracy is common in the People’s Republic of China (PRC or China), and the enforcement of intellectual property (“IP”) rights a daunting challenge. However, IP infringement is not just an issue for the RPC government. Most foreign companies have done little to protect their IP rights in China, leaving their product susceptible to infringement. While the old saying “an ounce of prevention is worth a pound of cure” still rings true, much more than an ounce of prevention is necessary to protect your IP rights in China.

Before you do business in China, first ask yourself if your IP is vital to your China business. If it is, you may need to seriously assess whether or not you wish to introduce your technology in China and if you decide to do so, you need to ascertain, as part of a comprehensive marketing plan, how long you are likely to have control of your IP before infringers start to erode your market share.

You need to secure your key IP assets in the U.S., regardless of what happens in China. Registering US trademarks, copyrights, and patents is a prerequisite to taking legal action against a distributor of “knockoffs” that originate in China, and is a good first step.

Recording registered trademarks and copyrights with U.S. Customs and Border Protection can also help stop pirated goods at the border, before they enter the stream of commerce in the US.

Registration of your IP in China is necessary, although not sufficient, to protect your IP rights in China. If you don’t file your IP in China, you have no rights in China. Therefore, you must register your IP in China before introducing it to the Chinese market place.

Trademarks are protected on a first-to-file basis, with an exception for well-known trademarks. Do not rely on the “well-known” exception, however (unless you are Coca-Cola), because whether a particular trademark is “well-known” or not is a time-consuming argument that keeps IP lawyers in business all over the world. If a trademark uses words, the closest Chinese language equivalent and their variants should also be registered.

Patents are also granted on a first-to-file basis. In China there is a hole in the registration procedure for patents, which requires they be registered with the State Intellectual Property Office (“SIPO”) and placed on public file for assessment prior to the patent being recognized as your IP, even if the first public disclosure or use of the IP is in the U.S. As a result, many Chinese entrepreneurs monitor all patent applications specifically to steal IP and immediately produce products containing the IP while the patent pending process is ongoing.

You can challenge patent decisions made by the Patent Reexamination Board (PRB) of SIPO by using the process of judicial review. The judicial review of PRB decisions covers decisions made during reexamination and invalidation proceedings. The judicial review of PRB decisions is an important – but underused- patent protection mechanism in China. As of June 2006, 497 PRB decisions have been brought to courts for judicial review, only 11% of which were brought by non-mainland parties. In particular, only six were brought by US parties. Foreign parties often seem to believe that they cannot win in Chinese courts and agencies. Pfizer’s success in wining the Viagra patent case (though an appeal is pending) and the fact that non-mainland parties have lower losing rates than their counterparts in mainland China suggest the need to reconsider this belief.

China started drafting the third amendment to the Patent law in January 2006 and the amendment is expected to be completed in 2008. Under the third amendment, when an invention is “completed” in China, the patent application must be filed first in China unless the applicant obtains prior approval from SIPO for foreign filing. This new rule will apply regardless of citizenship and will, in effect, prevent a foreign parent company from choosing where the patent application is to be filed first.

Early registration of copyright rights, while not required, is also advisable. Registration serves as useful evidence of ownership of a copyrighted work, but it is not a legal precondition to enforcement.

There is no registration system for trade secrets, so protection is a matter of taking practical and legal measures to maintain confidentiality, including the use of confidentiality agreements. The best way to protect trade secrets is simply to limit their disclosure to employees or business partners in China. When disclosure is necessary, first establish a relationship of trust with your Chinese business partners.

What else should you or can you do even if you have your IP registered in China?

First: Control your production processes. You can segment your manufacturing processes which will make it difficult for counterfeiters to successfully infringe on your IP. By establishing a wholly foreign-owned enterprise structure, rather than a joint venture, you can retain control over both the technology and the manufacturing process. By retaining control over the assembly phase of the operation, you can ensure that no other manufacturer has access to your complete manufacturing process. Sourcing key components from several manufacturers will prevent any one of them from being able to manufacture the complete product.

Second: Strengthen your workplace security. Investigate the reputation and trustworthiness of all applicants for sensitive positions during the recruitment process. Include non-compete and non-disclosure agreements in labor contracts. Create a “plumbing” system to control IP leakage in the workplace. IP systems and any hard copies of IP should be kept in an access-restricted, secure location. Confidential information should be distributed on a strictly “need to know” basis. It is also good policy to separate engineers who possess knowledge of your production process from the sales force who have access to your clients.

Third: Carefully select your partners in China. It is important to have a trustworthy business partner in China. Each prospective business partner should be carefully checked for their track record in IP protection and for their financial and business experience. Research their networks and identify weak points through which counterfeit products could enter the distribution network.

Fourth: Aggressively prosecute infringers and defend your IP rights. Protecting your IP assets in China is all about vigilance in detecting infringement and in pursuing infringers. Your legal rights mean little in China unless you choose to protect them. Invest appropriate resources in anticounterfeiting efforts, paying particular attention to the investigation and identification of the main players. You can choose from several routes to enforce you IP rights, including civil, administrative, and criminal actions. Don’t be afraid to take legal action in China. Although the Chinese legal system is not perfect, it does function. In 2005, the success rate for foreign IP owners was over 90%. This statistic alone should courage you to use the court system to resolve any IP related dispute in China.

Take-away lessons:1) Register your IP in the USA; 2) Register your IP in China; 3) develop and implement a multi-pronged strategy to protect your IP rights in China; and (4) if you have evidence of infringement, aggressively defend your IP rights.

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Mistake #5- Representative Office

May 7th, 2007

Opening a representative office (RO) may be the easiest way to make for making your entry into China because it allows you to ‘dip a toe into the water’ before committing yourself. However, it is not always the best way. From the corporate dynamics perspective, a RO may be far less advantageous than other available organizational structures, such as a wholly foreign owned enterprise (WFOE).

A RO may engage only in indirect business activities within China. A RO’s function is limited to serving as a business liaison for its foreign parent. It is not a legal entity recognized by Chinese law and is not competent to engage in commercial activities within China. A RO cannot do the following: (a) sign contracts with suppliers or customers in its own name; (b) apply for an import/export license; (c) qualify as a taxpaying entity; (d) open bank account; (e) employ staff directly (a RO must use the Chinese version of Manpower in hiring its staff); and (f) issue invoices.

A WFOE is not so limited to its business activities. It is a legal entity in China and is entitled to perform all commercial activities of a company in China, including signing contracts; employing staff; applying for an import and export license; issuing invoices; opening bank accounts; and engaging in financial transactions.

The difference in the taxation of these two entities in China may determine your choice of a WFOE over a RO.

A RO has to run more or less as a ‘cost center’ or sales or promotion office of the foreign parent. A RO pays taxes on all expenses, including the RO’s employees’ salaries as well as payroll and social insurance taxes. These funds must be paid from the RO company account. Then the RO, which first pays taxes on all expenses — pays taxes again on the paid funds — for they were expenses that the RO paid and passed through its business account. A RO pays taxes at the rate of approximately 10.5% on every dollar that passes through its bank account. Therefore, the more it costs to run the RO the more the RO pays in taxes (subject to the caveat ROs in different industries receive different tax breaks).

A WFOE pays taxes on profits for two years and for the next three years pays taxes only at half the then prevailing corporate tax rate. However, because of the intricacies of Chinese tax laws, there is also a way for a WFOE to remain tax free for a much longer time. The Chinese Corporation Code specifically permits a Chinese company of any kind, including a WFOE, to operate tax free during any period where it does not show a profit. Meaning, you can start a WFOE with a lower level of capital investment, and rather than post ‘profits’ on the WFOEs’ books, those funds can be used to expand the operation of the WFOE in China — which legally delays the beginning of the two year tax free period.

Notwithstanding the above operational and tax benefits, we do not recommend a WFOE over a RO under all circumstances.The following scenarios may justify establishing a RO instead of a WFOE:

You also need to understand there are some disadvantages of establishing a WFOE. It is more costly to set up and administer than either a RO or a JV. Potentially little or no local knowledge is attached. Time frames can be extensive. WFOEs are required to invest registered capital as required by the government approved mandatory investment schedules, while there is no such requirement for the establishment of a RO. The granting of an entry permit and government supervision is generally loose on ROs and strict on WFOEs. In the case of WFOEs, the qualification and market position of their overseas parent companies is considered by the government before an entry permit is granted, whereas in the case of a RO, the requirements for an entry permit are not as strict.

Take-away lesson: there is no bright-line rule deciding which organizational structure you should take to establish your business presence in China. Various factors need to be considered before you know which structure is suitable for your business presence in China.

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