United States exports to China have increased more than 500 percent since China joined the World Trade Organization in 2001, and the country now ranks as NH’s fourth largest trading partner, totaling $298.6 million in exports in 2014. As such, China presents unique opportunities for NH businesses of all sizes hoping to expand their production or exports overseas, especially since China’s economy has grown at a rate above 7 percent annually since 2009. (In early 2015 it slowed to 7 percent.) Small and medium sized businesses represent about nine-tenths of American businesses exporting to China and about one third of the exports’ value.
The U.S. Government estimates that by 2020, China’s middle class will grow to about 700 million people. Yet with these opportunities come challenges, such as a rapidly changing economic landscape, a dramatically different business culture and legal system. In addition, China’s GDP growth continues to slow, wages are rising and the Chinese government increasingly protects Chinese companies. So how does a NH business navigate this lucrative, yet complicated, marketplace?
China’s Business Culture
Business in the United States revolves around contracts, negotiated regardless of whether the companies have a pre-existing relationship. Once signed, all parties understand that there is a lasting agreement that, if necessary, courts will enforce. This facilitates transactions between strangers who can confidently rely on each other’s contractual promises.
Chinese culture, including businesses, relies heavily on systems of relationships, developed over time and cultivated regularly (“guanxi”). These personal relationships develop essential trust between the parties. Without this crucial underpinning, an agreement may not suffice to ensure performance or payment.
In western nations, success comes when a deal is completed, and a good contract matters more than what it took to achieve it. In China, the means taken to achieve the end can be just as important, if not more important, than the end product. Chinese negotiators may focus more on saving face than completing the deal, and expect extensive haggling, even over items that seemed completed. This can lead to longer, more expensive negotiations.
Businesses wishing to do business in China must take time to form relationships with Chinese partners, agents and contractors and to negotiate patiently. The costs are an essential investment. American businesses should go to China to scout locations, determine local conditions and establish personal relationships with key people. Export contracts should make the customer legally and functionally responsible for the products upon arrival in China (before clearing customs) so the customer’s relationships guide the products through customs, insurance, transportation and related processes and paperwork in China.
Government Involvement
The Chinese government involves itself in the private business sector to a degree rarely seen in the west. China still has a planned economy and, in recent years, has become protective of Chinese enterprises. Businesses in China are frequently state-owned enterprises, which adds bureaucracy and may slow transactions. Local contacts can help a business navigate the bureaucratic maze and provide important continuity (and guanxi), but the clash of cultures can create serious risks under the Foreign Corrupt Practices Act.
The Foreign Corrupt Practices Act of 1977 (FCPA) prohibits the corrupt payment, promise or gift of anything of value to a foreign official to influence any act or decision of the foreign official in his or her official capacity, to secure any improper advantage, or to use his or her influence with a foreign government in an effort to assist a U.S. company to obtain or retain business. The FCPA factors heavily into doing business in China because of a deeply ingrained expectation of side gifts to officials who handle successful deals. Bloomberg even stated China has a “bribery culture” that is centuries old, deeply ingrained, and unlikely to change in the near term.
Given this history, agreements with locals should specifically lay out what they can and cannot do in the course of their representation and provide the U.S. business with enforcement rights to ensure compliance. For example, allowing U.S. businesses to conduct independent audits or terminate agreements can effectively guarantee compliance.
Protecting Intellectual Property
China’s intellectual property protection differs greatly from the United States’ system, particularly in obtaining and enforcing patents. Despite having undergone dramatic changes in the past several years, intellectual property protection still presents problems.
For example, where U.S. patents have a 20-year life, China offers patents for inventions with a life of 20 years and utility and design patents with a 10-year life. Utility patents (issued for the invention of a new and useful process, machine, manufacture, or composition of matter, or a new and useful improvement) are only subject to substantive investigation during invalidation proceedings, rather than during the application stage. This expedites patent issuance (commonly one year as opposed to the three to five years it takes to receive a utility patent in the U.S.), which lets the company holding the utility patent begin pushing competition out before rivals can get an invention patent. China excludes from patent protection such things as business methods and animal and plant varieties, which U.S. patents may better protect.
Only attorneys licensed to practice in China may file for a Chinese patent. Here again, the quality of the local representatives and length of the relationship are critical. Filing a patent with strong local support, backed by long-term business relationships, is frequently the difference between getting a strong patent for the right price and getting an ineffective patent or paying far too much.
China’s enforcement procedures can pose additional hurdles, even though the enforcement system is improving. Foreign entities now win the vast majority of patent infringement actions, and the number is rising. Unfortunately the judgments remain relatively toothless. If assessed at all, financial remedies are usually only statutory damages of between $1,500 and $150,000, after which infringing companies may reopen under a new name.
China is still notorious for its pervasive intellectual property infringement. American businesses should consult their intellectual property attorneys before putting their products at risk of infringement or reverse engineering.
Letters of Credit
American companies doing business in China often worry about getting paid. Given the Chinese customers’ approach to contract obligations, prudent American businesses should not rely on open accounts or document-based collections. It is best to get the biggest upfront payment. To secure the balance, properly drafted letters of credit, though costly, commonly provide an effective solution.
Letters of credit (a bank document guaranteeing that a seller will receive payment in full as long as certain delivery conditions are met) require careful negotiation and strict adherence to their requirements. Horror stories abound of letters of credit failing due to spacing or typographic differences, so attention to detail in paperwork and dealing with honorable banks is the best way to ensure payment succeeds. Consult counsel and only use irrevocable letters of credit, under which the bank must pay the exporter even if the buyer defaults.
Not all banks will handle letters of credit with a correspondent Chinese bank, and each bank’s reputation is important, since both parties are relying on integrity and ability to perform their obligations. A seasoned banker and an experienced attorney are the first steps in ensuring proper payment.
Dispute Resolution Clauses
Chinese courts are often loath to enforce U.S. law and judgments. Aside from the “home court advantage,” Chinese courts can misunderstand the law, reluctantly or improperly apply foreign laws, or ignore foreign laws altogether.
In the 1980s and 1990s, China signed several key international treaties and conventions that make its commercial law more reliable. Among them are the Vienna Convention on the International Sale of Goods and the Madrid Treaty on Trademarks. Since there is global “peer pressure” to adhere to signed treaties, your attorney should make sure international law is superior to national law and insert arbitration clauses that list acceptable neutral countries with established commercial traditions for hosting dispute resolutions.
China’s 2011 Statute of Application of Law to Foreign Civil Relations unified China’s choice of law statutes, established a choice of law framework, and moved China closer to its goal of a comprehensive civil code. This helps Americans doing business in China but does not solve any problems. Chinese courts must resolve choice of law disputes by interpreting the vague command that foreign law may not control if “application of foreign law would harm the social and public interests of China.” Additionally, certain contract types, such as those dealing with natural resources or creating joint ventures between Chinese and foreign companies on Chinese soil, require that Chinese law apply, regardless of the parties’ agreements.
There is no simple answer as to how to best draft a choice of law provision to protect a contract’s enforcement in Chinese courts. A United States judgment against a Chinese company will only help if the company has resources in countries that will enforce the judgment or if the judgment puts the Chinese company under business pressure.
Reference to an international arbitral body can help but may not always be enforced. Chinese businesses readily agree to use Hong Kong law and jurisdiction in contracts, which Westerners often find preferable to Chinese law and jurisdiction. Jurisdictions perceived neutral by both parties (such as Sweden) also suffice. Local Chinese counsel can assist greatly in navigating choice of law and dispute resolution issues when drafting contracts in the first place.
With a huge market, China presents a worthy target for ambitious, yet careful American enterprises. By noting these concerns, working closely with legal counsel in America and fostering strong local relationships with professionals on the ground in China, Americans doing business in China can succeed while avoiding time and money wasting pitfalls. n
Janet B. Fierman is a shareholder at Sheehan Phinney Bass + Green in its Massachusetts office. Grant Gendron is an associate in the firm’s Manchester office. Fierman can be reached at 617-897-5648 or jfierman@sheehan.com. Gendron can be reached at 603-627-8273 or ggendron@sheehan.com.