Last Tuesday, some 4,000 protesters gathered outside the Japanese embassy in Beijing, hurling rocks and bottles and burning the Japanese flag. The day was the 81st anniversary of the Japanese invasion of China that kicked off World War II in Asia, but the demonstrators were really responding to a more recent Japanese encroachment—its purchase earlier this month of a chain of uninhabited islands also claimed by China.
 
In the weeks since, Chinese demonstrators in Qingdao set fire to a Panasonic Corp. factory and looted a Toyota dealership. Vandalism of Japanese cars, restaurants, and shops has been seen in most big cities in China. Anticipating that the riots would reach a fever pitch Tuesday, most Japanese businesses in China were closed that day, and many Japanese expatriates have headed home, at least until things cool off.
 
“About 60 percent of my clients have come back, tentatively, to Japan,” says Toshiyuki Arai, a Tokyo partner for Paul Hastings who mainly represents Japanese and U.S. companies investing in China.
 
The relationship between China and Japan has always been complicated by their wartime past. The recent flare-up is over a chain of islands that Japan currently administers but that China also claims—the Chinese call them the Diaoyu and the Japanese call them the Senkakus. Earlier this month, at the urging of right-wing groups, the Japanese government paid $26 million to buy the islands from private Japanese owners. That was the spark that set off nationalist protests across China.
 
The protests subsided late last week, but the war of words rages on. In a commentary published Monday, China’s official Xinhua news agency called Japan’s $26 million purchase of the islands a “farce” and warned that there might be economic consequences for Japan. Likewise, Prime Minister Yoshihiko Noda of Japan told The Wall Street Journal Sunday that the Chinese protests could frighten foreign investors.
 
For lawyers focusing on cross-border deals between the world’s second- and third-largest economies, none of these thoughts are comforting.
 
“They’re mightily concerned,” says Arai of his clients. “They have lots and lots of yen and dollars on the ground.”
 
Though lawyers active in Japan practice say they’re not aware of any deals being canceled so far, they say it is possible that some Japanese companies may be rethinking their commitments to the China market. Many of their employees on the ground have left China temporarily out for fear for their safety, though no one was hurt during the protests.
 
One Japanese lawyer who stayed behind says that though the streets have calmed, the dread of being targeted is still palpable. “It’s becoming better, but I still have some feeling of being scared,” he says.
 
It’s not the first time anti-Japanese riots have swelled in recent years. Seven years ago, anger over Japanese textbooks that minimized the country’s responsibility for the war led to large demonstrations in China and similar acts of vandalism. But there is widespread agreement that last week’s demonstrations were worse.
 
“This is so much beyond what we saw in 2005–06,” says Arai.
 
The atmosphere complicates even the most basic interactions between Chinese and Japanese. Arai says even the simple collection of debts from Chinese customers may best be left for another point in the future. “You simply lay low and don’t do very much,” he says.
 
The Japanese lawyer in Beijing says there are fears that the Chinese government may be engaging in economic harassment. In the past, he notes, the import and export of Japanese goods through Chinese customs have slowed during times of political tension. The approval of permits and other business licenses may also see delays. This translates into a loss of revenues for those investors.
 
In his comments Sunday, Noda was reacting in part to reports that similar punitive measures appear to be occurring again.
 
“All of the Japanese companies are very disappointed,” the lawyer says.
 
For small and midsize Japanese companies that have historically been hesitant to invest overseas, the blow-up may make the prospect of entering the China market even more off-putting. Some lawyers think there may be some shift in investment toward markets seen as more congenial, like Southeast Asia.
 
Still, the Sonys and Toyotas have already made massive investments in China, which has been Japan’s largest trading partner since 2007. Japan is China’s second-largest among individual nations. The fact that economic ties are already so deep is a major reason that many lawyers think tha any slowness resulting from the protests will be short-lived.
 
Koshi Ishikawa, a Tokyo-based partner at DLA Piper, says that “for a time,” Japanese companies may be shy of China investments. But in the long run, China still needs Japan’s advanced technologies to continue growing its economy, and Japan continues to import more and more Chinese goods. 
 
“I think it’s just a temporary situation,” he says, adding that, while his Japanese clients are cautious, none feel threatened enough to pull out of the Chinese market.
 
Other lawyers echo that sentiment.
 
“In Japan, we’re not taking it as seriously as the media is making it out to be,” says Michael Mies, a mergers and acquisitions partner for Skadden, Arps, Slate, Meagher & Flom in Tokyo.
 
Mies remembers leaving his Japanese colleagues at home when firm partners visited Shanghai for a business trip during the protests of 2005, so he doesn’t discount the protests taking in place in China now, but he says it’s too early to tell what kind of impact this could have on Chinese-Japanese business relationships.
 
“If anyone is saying otherwise, I think they’re being a bit quick on that,” he says.
 
Mies has noticed no change in attitude among the firm’s mergers and acquisitions clients since problems began in early September. And while the unrest adds one more potential risk for Japanese investors in China, along with transparency and regulatory issues, the market there still offers the growth that all companies crave. 
 
“They all want to be there, and that’s why I don’t think this spat is going to be a long-term hit,” he says.