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Six years ago, InsideCounsel provided readers with a comprehensive legal guide designed to offer insight to companies about best practices when considering expanding their businesses into China’s burgeoning marketplace. We reported on the workings of the country’s court system, its outlook on intellectual property, its stance on environmental law, its evolving labor laws and more.

It comes as no surprise that China’s legal and business landscapes have markedly changed since that story appeared in the magazine in November 2006. In this article, we offer an update on the latest developments that are affecting how U.S. companies do business in China.

Business Basics

There’s no mystery about why it’s important for corporations to establish themselves in China.

“Any company that wants to be global has to be in China,” says Lee Cheng, chief legal officer at Newegg Inc., an online retailer of IT and consumer-electronic products that does business in China. “It’s the fastest-growing market in the world and the world’s second-largest economy. It’s potentially going to be the biggest economy in the world within two to three decades.”

Luckily for multinational companies, it is relatively easier to break into China’s market than it was just a decade ago. “China has been on a trend of being friendlier to business and opening itself up in terms of the global market,” says Christian Na, deputy general counsel of Circor International Inc., a manufacturer of products used in the energy, aerospace and industrial markets that does business in China.

Nonetheless, China’s government still plays a large role in controlling business within the country. “Virtually at every turn, you need government approval to engage in various activities, expand your business scope or do business in another city,” says David Tang, managing partner, Asia at K&L Gates.

Dick Goetz, a partner at Dykema and head of the firm’s International Practice Group, notes that during the past decade, the central government has delegated more business-regulating authority to the local level, which is more open to foreign investment. But “there is still some degree of protectionism, especially in local industries,” he says.

Evolving Laws

Companies looking to establish a physical presence in China must have a grasp on the country’s evolving business laws. “In the past, there was a sense that there were no rules and that you could do anything to achieve the goals that you wanted to achieve. Now, a decade later, that is no longer true,” says Tang. “There are lots of rules and regulations being enforced. People who don’t comply end up in hot water.”

To stay informed about China’s growing body of business law, Julia Zhu, senior counsel at Dykema, recommends developing relationships with local experts. “All the laws, regulations and rules are not readily available online or somewhere else the public has access to,” she says. “Those rules and regulations are coming from different authorities in China. Some of them are consistent, some of them are inconsistent. Local, experienced lawyers are a great source to keep companies abreast of what’s going on in China from a legal perspective.”

Corruption Concerns

In addition to understanding China’s laws, companies must adapt to the country’s business culture.

“China is still very much about guanxi—the personal relationship,” says Na. “Personal relationships are as important as any written document or contract. Guanxi is really supposed to be something that generates goodwill and facilitates business in a legitimate way, but at the same time, that guanxi relationship can be abused. That’s what leads to undue business influence that may be interpreted as bribes or corruption. It’s a fine balance that multinational companies have to understand and handle very well.”

And although Western companies doing business in China and local Chinese business partners have become more cognizant of Foreign Corrupt Practices Act (FCPA) issues in the past decade, bribery concerns still exist.

“FCPA is a growing concern for multinational companies, as Department of Justice enforcement has been quite rigorous recently,” says Tang. “There have been very heavy fines on violators. It is very high on the risk agenda of multinational companies, and they are taking seriously the admonition to train, monitor and investigate if there’s any indication that something is wrong. That’s also a focus on the Chinese side. There is an effort to combat corruption.”

Leadership Shake-up

At press time, China was preparing for the 18th National Congress of the Communist Party of China, scheduled for Nov. 8, during which important government and party leadership changes will take place. Experts say the changes could have a big effect on Chinese businesses as well as businesses operating or investing in China.

“There is some discussion that there needs to be greater economic reform in China,” says Tang. “There is a little bit of uncertainty as to what direction policy will take, and if there is reform, what kind of reform this will be. For some companies in certain sectors, that could be very welcome. For other companies, for instance, large-state-owned enterprises, that may not be as welcome because they’re comfortable in the current system.”

Goetz agrees. “Given that China’s economy is starting to bump a little bit, they probably are going to be more interested in foreign investment,” he says. “This might not be a bad time to invest in China because of the opportunities that will be available.”

Changing Courts

Although China operates under a civil law system and therefore isn’t bound by stare decisis—or the rule that lower courts must rely on judicial precedent when deciding cases with similar issues—changes to the country’s court system indicate a move toward ensuring more uniform decision-
making among courts.

On Nov. 26, 2010, the Supreme People’s Court of China (SPC) promulgated the “Provisions on Work Related to Guiding Cases.”

“A guiding case is a court judgment or ruling handed down by a court, which can be the SPC or a lower court,” explains Song Zhu, a partner at Hogan Lovells. “The provisions set forth the goals of guiding cases, their selection criteria and process, and their use.”

According to the provisions, the purpose of this effort is “to summarize adjudication experiences, unify application of law, enhance adjudication quality and safeguard judicial justice.”

“In other words, the purpose is to improve the quality, consistency and uniformity of adjudication of cases, and to provide examples of sound judicial decision-making to China’s relatively inexperienced judges,” Zhu says.

Guiding, Not Binding

So far, the SPC has released eight guiding cases. But experts stress that they aren’t binding.
“Based on my discussions with the SPC’s judges, the purpose of the provisions is not to make new law or to establish binding precedents,” Zhu says.

However, Mei Gechlik, director of Stanford Law’s China Guiding Cases Project, which is creating a database of translated guiding cases and commentary, says SPC leaders have told her
that although the cases aren’t binding, “if they are not followed, there will be serious problems.”

According to Zhu, some experts say the guiding cases are “the initial step of the SPC’s effort to establish something that is akin to the common law, marking a fundamental change to the Chinese legal system.” But some Chinese judges Zhu spoke with disagree. “They pointed out that under China’s constitution, only the National People’s Congress—China’s legislature—can make new law. The SPC is careful not to step outside the boundary of its authority.”

Forthcoming Cases

So far, none of the guiding cases have been particularly pertinent to foreign businesses operating in China. But Gechlik predicts that the next batch of guiding cases will include an intellectual property case. “They want to make sure that they release some simpler cases first, and then when they feel more confident, they will deal with the more important, technical cases like IP because they know that international parties will be more interested in those kinds of cases,” she says.

Becoming Independent

Despite these promising changes, experts say there is still a long way to go before China’s courts are truly independent. Gechlik says the judicial system’s fundamental problem is Communist Party control over the personnel and financing of the courts.

But the lower courts, especially in China’s major metropolitan areas, are slowly acquiring better-qualified judges who are more open-minded and reform-oriented in their decisions than their predecessors. And with government and party leadership changes on the horizon, there could be further improvements—though experts aren’t overly optimistic.

“We will have to see whether the new leaders will have the courage to actually bring about meaningful political reform,” Gechlik says. “Without that, we won’t see major changes in the judicial system. It’s not realistic to expect true independence in a system like China. It’s still too difficult to realize big changes.”

Improving IP

A country long known for its manufacturing, China has been trying to move from “Made in China” to “Designed in China” by promoting indigenous innovation. China hopes to increase the number of patent applications filed in the country to 2 million by 2015, even though it already had the most patent applications in the world in 2011—1.63 million.

To reach this lofty goal, the government supports tweaking foreign technology, defining indigenous innovation in its science and technology development plan as “enhancing original innovation through co-innovation and re-innovation based on the assimilation of imported technologies.”

This sentiment “is considered by many international technology companies to be a blueprint for technology theft on a scale the world has never seen before,” according to a 2010 U.S. Chamber of Commerce report. This can leave some companies that want to take advantage of China’s growing economy worried about protecting their intellectual property on the other side of the Pacific.

“It’s the second-largest economy in the world,” says Thomas Ross, a partner at Marshall, Gerstein & Borun. “How can you ignore it? But by the same token, you don’t want to go over there and get ripped off.”

However, perhaps as part of its ongoing attempts to promote innovation, China has made strides toward better protecting IP.

“I know that in the past, China might have received a somewhat less-than-stellar reputation for protecting IP,” says Horace Ng, managing IP counsel and director of IP development at Marvell Semiconductor Inc. “But over the years China has done its share of improving its IP system, so people are getting more confidence in investing their resources in China.”

Patent Protection

One of the problems China has addressed is the issue of patent hijacking—registering in China for patents on inventions that are already patented elsewhere in the world. This used to be legal, Ng says, because anything published outside of China did not count as prior art that could invalidate a patent application within China.

“Now they have changed the law to eliminate that loophole,” Ng says.

A recent opinion from China’s Supreme People’s Court (SPC) also offers some reassurance to patent holders. According to Alex Zhang, a partner at King & Wood Mallesons, the SPC said that “defendants will bear the reverse burden of proof” in patent cases if the patentee can prove that the infringer manufactures the same product and shows a high likelihood of infringement.

In light of this, Zhang recommends that “whenever you find something, you need to be quick to enforce your IP,” especially because litigation in China is far less expensive than in the U.S.

Those companies looking to avoid court proceedings can seek administrative actions through local intellectual property offices.

“You’re apt to get a quick order that way, and also an order that is enforceable by a government official, which is taken pretty seriously over there,” Ross says.

Controlling Contracts

Official action can only go so far, though, if businesses are stuck in their ways. “The legal system’s trying to catch up,” Ng says. “But at the same time, the customers that we have to work with are lagging behind a little bit in terms of their knowledge of the legal system and what they are not supposed to do. … We have seen cases where some bigger customers actually try to get IP ownership of things we develop.”

Ng recommends that companies employ someone who can read and write Chinese to review contracts and look out for such worrisome provisions. Looking at a translated English contract isn’t always enough because often Chinese companies will request that the Chinese version of the contract be the governing version.

Employment Environment

Despite recurring media reports of poor working conditions in China at places such as electronics manufacturing giant Foxconn’s factories, experts say that Chinese worker rights have been steadily improving over the past six years. While labor rights activists may not yet be satisfied, Ricardo Ernst, a professor of global logistics at Georgetown University, says progress in China should not be measured against another country’s standard.

“It’s not a fair comparison to say that the working conditions in the U.S. are the same as the working conditions that they [should] have in any and every other place around the world,” Ernst says. “Every place has its own working conditions, and that’s why you need to evaluate in light of what the local conditions are.”

Useless Unions

In 2006, InsideCounsel reported that the Chinese government was planning a push to give more power to its central union, the All-China Federation of Trade Unions (ACFTU), and we predicted this would contribute to the strengthening of workers’ rights. In 2010, a spat of labor strikes erupted in several large factories. Once the dust settled, the Washington Post reported in 2011 that the ACFTU was going to make a bigger effort to lobby on behalf of workers.

However, Dan Harris, a partner at Harris & Moure and co-author of the firm’s China Law Blog, says that although the Communist Party wants China to believe the unions have teeth, union issues have never come up for any of his corporate clients in China and he believes the ACFTU is controlled by the government.

“There’s no real union. It’s the government that’s telling them what to do and when,” Harris says. “That’s not really a union.”

He wrote as much in a blog post for China Law Blog in September, and says the website was immediately shut down in China.

“If I had thought about it, I would’ve known they would shut me down because China does not like people to say ‘The unions? What unions?’” he says. “This whole thing about [how] they’re going to advocate for the workers and all that? Bull.”

Labor Law

If the improvement in workers’ rights isn’t coming from the unions, perhaps it can be attributed to the Labor Contract Law, which went into effect on Jan. 1, 2008, despite many employers’ efforts to defeat the legislation. Several of the law’s provisions, including requiring written contracts and overtime pay, have driven up labor costs for companies operating in China.

But it’s not all bad news. Requiring contracts means companies have their rules and policies in writing, which makes them much easier to enforce.

“If the rule of law is not enforceable, then you have a high level of risk,” Ernst says. “Requiring contracts is a very good idea. … The transparency of rules is, at the end of the day, what brings success.”

Harris recommends writing contracts in both Chinese and English, and doing the same for employment manuals, which should include a detailed list of all the reasons employees can be fired. “China is not an at-will employee country,” Harris says. “Americans tend to be the ones that get in the most trouble in China because [they] just assume you can fire somebody easily because in the U.S., you can. In China, you can’t.”

Overall, Harris says foreign companies have to be a lot more careful to comply with labor laws than Chinese companies because they are scrutinized more closely. “Don’t do what the Chinese company does down the street,” he says. “Don’t do what your Chinese manager says you can get away with, because you won’t get away with it.”