A changing Chinese economy coupled with more longstanding corruption and political interference could cause clients to think twice about doing business in the country, and, as a result, make law firms rethink the already tenuous financial proposition of having an office in China.
But is China too big to ignore?
In the last year, a number of Am Law 200 firms have pulled out of the market altogether or consolidated their offices in the country. As ALM affiliate The Asian Lawyer reported in January, the number of foreign legal offices in China was at its lowest since 2012 as firms such as Chadbourne & Parke and Fried, Frank, Harris, Shriver & Jacobson closed shop in China.
Foreign direct investment into China has slowed in recent months and lawyers are noticing clients becoming increasingly skeptical of whether the rewards of doing business in China outweigh the risks.
James Carbin, a partner in the Newark, New Jersey, office of Duane Morris who focuses his practice on insurance, reinsurance and international trade, said the growing concern for companies whose products are manufactured in China stems primarily from supply chain problems, including, among other things, poor quality control and damaged or missing cargo.
But compounding those issues is the fact that seeking recourse in the Chinese judicial system can be a dicey proposition, Carbin said.
“In my experience, I would say that the results [in cases litigated in the Chinese judicial system] seem to be uneven and I’ve had similar cases with dramatically different results in different courts” across China, Carbin said.
As a result, some companies have come to view the Chinese judiciary as too parochial, according to Carbin.
“There has been … a general recognition in the market that if China is going to continue to grow and invite foreign investment and capital it’s going to have to demonstrate to foreign investors that [their investments are] going to be protected through a judicial system that is fair and even-handed,” he said, noting that he often recommends that his clients’ contracts provide for arbitration in a neutral venue.
But David Woronov, a partner in the Boston office of Newark-based McCarter & English who represents U.S. and foreign clients in international transactions, said that while the Chinese judiciary has unquestionably been touched by corruption and scandal, some of the problems foreign litigants face in Chinese courts are purely of their own making. For example, Woronov said, some U.S. and European companies make the mistake of believing they can take the same approach to contracts with Chinese companies that they would with domestic companies.
“If you don’t have a master contract in Chinese [that applies] Chinese law, you’re going to be shown the door–quite literally,” Woronov said. “Having enforceable contracts at this point is really important: China cannot afford to openly flaunt its laws with respect to enforceable contracts” because doing so would likely repel potential foreign investors. “They have more clandestine and surreptitious ways of helping their domestic companies, such as through regulation,” he said. “They’re much quicker to drop a dime on American or European companies” than they would be with a Chinese company.
Drafting a contract that would be enforceable in China, Woronov said, means enumerating, very specifically, the various problems that could arise, along with the attendant damages that would be sought.
Woronov said there have been several instances of foreign companies and their attorneys unnecessarily spending significant amounts of money litigating in Chinese courts only to have the contract at issue invalidated because the wrong party signed it.
Still, Woronov said China is in some ways less risky for foreign investors than it was even 10 years ago and continues to be a safer place for importing and exporting goods than alternatives like Thailand, Pakistan and India.
Instead, the real problem for foreign companies that rely on China to make their goods cheaply, Woronov said, may prove to be the country’s growing middle class.
“At some point China’s going to be like the U.S.: too expensive to manufacture the junk it’s manufacturing,” he said.
Altman Weil consultant Ward Bower said there are divergent views in the legal industry on the need to be in China.
“I think there was a rush to get to China partly because everyone was doing it, and all economic indicators said it was a growth opportunity,” Bower said.
But firms never really figured out a way to make money there, he said.
As a result, some firms have conclusively decided it is not worth the investment and closed their offices in the last two years, Bower said. Many were trying to wait out the economic trends but found the outlook too grim for too long to stay any longer, he said. Other firms, Bower said, have taken the approach that it is best to have a small location in China where the firm tries to control its expenses as best it can in an expensive market.
“They know the Chinese never forget anything and if they were to pull out they might never be able to get back in,” Bower said, noting the licenses required to practice in the country.
Many firms showed less patience when it came to similar economic and political difficulties that afflicted the Russian market in the last few years. After steady growth, a number of firms closed or shrunk operations in Moscow.
But for some firms, China just may be too big to ignore.
“It’s too big to not think about it, but it’s not necessarily too big to not enter,” said LawVision Group consultant Truda Chow, who spent the last 10 years living in Hong Kong, advising firms on Asian strategy.
Chow said China may be facing an economic slowdown, but it is still the largest economy in the world. The problem firms faced years ago was that they all jumped into China simply because it was such a large economy, but they never quite had a strategy.
“There is actually still a tremendous amount of opportunity in China,” Chow said.
And the shakeup in the economy is creating legal work, she said.
Dan Harris of Seattle law firm Harris Moure recounted in a column this year for Above the Law that China’s attempts to stop foreign currency from leaving the county is “literally changing how my firm’s China attorneys practice law.”
Harris said Thursday that firms aren’t hiring like they once did, but he isn’t aware of any looking to abandon the market.
“In fact, our firm and a number of [others] have never been busier because, with the downturn, we are seeing all sorts of deals, restructuring and companies scrambling to clean up their entire legal/compliance situation in China,” Harris said in an email. “We are even getting an increase in companies manufacturing in China and that may be due to Chinese companies cutting their prices.”
Kent Zimmermann of the Zeughauser Group said a firm’s practice makeup will dictate its success and interest in the Chinese market. Those firms doing significant cross-border, inbound M&A deals will need to be in China, he said.
And Bower, Chow and Zimmermann each pointed to the need to have Chinese nationals on the ground for credibility. Chow noted the importance of having attorneys on the ground in China who are familiar with the local regulations and how to navigate what is often perceived as corruption.
Some firms have said they have found more profitable ways of doing business in the Asian market, from offices in places with a stronger rule of law, such as Singapore. Bower said that has definitely proven a more viable option for some firms, though he cautioned that it can still be difficult to get work in China in the first place if a firm doesn’t have boots on the ground.
Bower said he views Russia and China as two different scenarios, with the crime, corruption and economic strife in Russia worse than what is seen in China.
Attorneys who spoke with ALM affiliate The American Lawyer in August 2015 largely maintained the “ride-it-out” approach when it came to China.
“We are long-term players,” said Roger Parker, the managing partner for Europe, Middle East and Asia at Reed Smith, at the time. Reed Smith has around 100 lawyers in Hong Kong, Shanghai and Beijing.
“For the present, it’s business as usual. [The stock market] doesn’t affect our long-term thinking,” Parker said.
Barry Genkin, who chairs Blank Rome’s Asia practice, told The American Lawyer in August that the key to having a successful practice in China is having an eye on the long term. Companies with a longer foothold in China know to expect the unexpected and not to panic whenever it looks like the sky may be falling.
“If you really focus on China, you need to focus on it over the long run,” Genkin had said.
Ultimately, there are still a lot of firms waiting on the sidelines, thinking about what to do in China, Bower said. But the slowdown in the economy has helped some of those firms make up their mind, he said.
Zimmermann said he expects more law firms to close their offices in China, while others will grow.
“Those that will grow there are going to have pre-eminence doing cross-border, outbound M&A work for large companies and others whose core strengths are in high demand for higher rate work in China,” Zimmermann said.
He cautioned that not every law firm needs to have an office in the country given the amount of money that is “falling out of China” in terms of that country’s investments in the United States.
But firms do need access to that work whether it be through an affiliation with a Chinese firm, a law firm network connection or a small shop in China that serves basically as a sales center, Zimmermann said.