China and Mexico: The Two Amigos? Part IV

In my first post, I discussed China’s efforts to build stronger economic ties with Mexico – and why Mexico should be clear-eyed about China’s motives. In my second post, I examined the current economic relationship between Mexico and China. In my third post, I explained why the economic relationship between China and Mexico has made so little progress. In this, my fourth and final post, I will look to the future and discuss how to improve the China-Mexico business relationship.

My first piece of advice is for Mexican companies to be realistic about what China wants and what China is truly prepared to do. Just because China offers itself as an alternative to Trump’s America doesn’t mean it is the right alternative, or even a good alternative. Every country has its own agenda and it would be foolish to think otherwise.

Beyond that, every Mexican company should ask itself if it is truly ready to do business with China, and every Chinese company should ask itself if it is truly ready to business with Mexico. It makes no sense to talk about strategic partnership without companies the right companies that are willing and able to profit from a reinvigorated relationship between the two countries. And in my company’s experience, there is a lot of work to be done on both sides, including the following:

• Companies must adopt corporate governance principles and incorporate due diligence into their everyday processes to ensure compliance with the other country’s laws and regulations.

• Mexican companies must make IP protection their top priority and register their copyrights, trademarks, and patents in China as soon as practicable. This advice applies whether they are directly operating in China or are merely operating in the US, Europe, or any other jurisdiction that would put them on the radar of a Chinese squatter.

• Executives must understand not just the relevant laws in the other country, but also the cultural mores and unwritten business rules – and the implications for their company. Mexican executives need to realize that they are both in charge of the Chinese operation and accountable for it. Similarly, Mexican companies should balance the obvious need to hire Chinese nationals with the need to retain personnel (probably expats) who “get” China but also understand Mexico’s business culture and are truly on the side of the Mexican company. This sort of cultural fluency is in many ways more important than language fluency.

• Mexican companies must move beyond the idea that they are direct competitors with their Chinese counterparts. Instead they should either engage in further specialization, or move up the value chain. Patents and trademarks and geographic indicators/appellations of origin can play a key role in differentiation. But being different only goes so far – if you don’t have a product Chinese consumers want, being different is irrelevant.

• Companies on both sides need the support of their respective government, as well as the counsel of qualified international lawyers. Many of the deals I see today have neither, but as the monetary value of the deals goes up, the rest will/must follow.

Almost all of the above address what private companies can do. But the Mexican government has a role, too. It needs to implement an effective economic agenda, and maintain progress toward North American integration.

An effective economic agenda involves more investment in trade intelligence and entering into trade and investment policy negotiations with China that are derived, as much as possible, from the political and ideological considerations that have characterized China’s relationship with many commodity-producing countries in our region. At the same time, Mexico needs to rise up the global value chain, and that requires investing in infrastructure, facilitating trade, and improving the quality of accreditation.

It may seem odd to talk about further North American integration against the backdrop of Trump’s rhetoric against NAFTA and against globalization. But China has long been the de facto 4th member of NAFTA and it’s silly to pretend otherwise. And given the enormously important economic ties among the NAFTA countries, a purely bilateral agreement (i.e., solely between China and Mexico or China and the US) seems increasingly unrealistic.

My company’s bottom line is that we cannot wait to see what Trump does or doesn’t do. Or for that matter, what China does or doesn’t do. China is not going to replace the US as Mexico’s largest and most important trading partner. Each Mexican company’s China strategy should be stand on its own terms. Mexican companies should expand into China because it makes sense to do so and because they think they can succeed there – not because they think China is going to replace the US as Mexico’s most important trading partner.

 

The above post is by Adrián Cisneros Aguilar. Adrian is the founder/CEO of Chevaya (驰亚), an Asia-Pacific internationalisation services company. Adrián has a Doctor of Laws from Shanghai Jiao Tong University and an LL.M. in International and Chinese Law from Wuhan University.

China Law Blog

China and Mexico: The Two Amigos? Part IV

Quick Question Friday, China Law Answers, Part XXXVIII

Because of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a super fast general answer and, when it is easy to do so, a link or two to a blog post that may provide some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

I came across your blog while researching employment contracts in China. Is there a standard amount of notice employees are legally required to give their employer when breaking a contract in China, or does it depend on the company itself? Also if I am going to give less time than is legally required, is it standard to pay for those days to exit the contract professionally? And is it standard to give the full amount of time or even more?

You are asking essentially two questions. One is a social/employment/morale/reputational one and the other is a legal one. We don’t know the answer to the question of how much time you should give in your particular industry or locale (especially since we do not even know your industry or your locale), so we would urge you to ask around so as not to harm your future employment chances in China (and if yours is a small industry, perhaps worldwide as well). As for the legal side, it should be whatever the employment contract says, so long as the applicable national, provincial, or local laws do not override that, which any one or more of these very well might. I urge you to read our post, China Employment Law: Local and Not So Simple. Unlike in most countries, it is not uncommon for China employers to sue an employee who fails to provide the legally required notice for leaving, so it is generally a good idea either to give the full notice that is legally required, or reach a written agreement with your employer letting you off the hook (probably by your paying money) for not doing so.

 

China Law Blog

Quick Question Friday, China Law Answers, Part XXXVIII

China and Mexico: The Two Amigos? Part III

In my first post, I discussed China’s efforts to build stronger economic ties with Mexico – and why Mexico should be clear-eyed about China’s motives. In my second post, I examined the current economic relationship between Mexico and China. In this post, I will discuss why the economic relationship between China and Mexico has made so little progress.

At first blush, it is difficult to understand the disjunction between what has been said and what has actually been done. The two countries have signed an Integral Strategic Partnership, and China has explicitly offered its assistance should the Trump administration turn its back on Mexico. The Chinese ambassador to Mexico has claimed the two countries’ relationship is “better than ever,” but trade and investment levels are pitifully low, and for a variety of reasons those numbers are unlikely to change.

One huge reason Mexico’s relationship with China is unlikely to change is the existence – and proximity – of the United States. The United States has a huge (and growing) Hispanic population eager to consume a vast array of Mexican exports, whereas Chinese consumers are only interested in a few select Mexican products. Just look at the numbers. Mexico’s annual exports are worth $ 400 billion, and $ 291 billion of that goes to the United States. Only $ 8 billion goes to China. The American government has not exactly welcomed China’s attempts to establish closer ties with Mexico, and there are strong rumors Washington played a big role behind the scenes in the cancellation of the Mexico City-Queretaro rail and the Dragon Mart Cancun projects. Even if the Mexican and U.S. governments are not currently best of friends, our two countries will always be neighbors.

It is also true that Mexico and China have little economic synergy. China is Mexico’s direct competitor in the United States and for many of the same products. According to a study produced by UNAM, the University of California, Berkeley and the University of Miami, from 2000-2011 both the U.S. and Mexico suffered substantial losses in their respective export markets in the NAFTA region. The study identified 52 sectors in Mexico in which the U.S. was losing market share and China was gaining, creating the inference that Mexico was making efficiency gains and had become more competitive in U.S. markets. However, the study found that Mexico was also losing market share in the U.S. in those same 52 sectors. In other words, China was outcompeting both countries — in part because of its advantage in manpower and its government subsidies.

The disconnects are on both sides. Mexico has failed to attract meaningful investment from China and instead focuses on Chinese tourism. Chinese companies have made little effort to do anything in Mexico beyond selling products to Mexican consumers. Mexico has failed to take advantage of China as an export market and has fallen back on sending China non-value added items such as tequila, pork, and fruit. The Chinese government does not make it easy for Mexican companies to enter the Chinese market. And China’s economic model depends on being able to run huge trade surpluses. Combine with this the devaluation of the peso and the rise in gas prices, and the result has been inflation that makes Mexican exports less attractive overseas. According to the Inter-American Development Bank, Mexico’s exports fell 4% in 2016.

Part of the problem has nothing to do with China and everything to do with Mexico. 99.8% of all businesses in Mexico are small and medium-sized enterprises (SMEs) and the vast majority of them are unsophisticated companies, with little interest in or knowledge of how to operate on an international scale. When these companies do seek to engage with China, some (or all) of the following problems arise:

• lack of due diligence about the Chinese market and possible business partners
• poorly implemented corporate governance structures
• failure to appreciate the paramount importance of IP protection, evidenced most often by discovering too late that a third party in China has registered “their” trademark
• lack of cultural and language proficiency on the part of Mexican staff, leading to an inability to deal with Chinese authorities
• inappropriate delegation of all responsibility for Chinese operations to poorly supervised Chinese staff
• lack of transactional oversight due to (relatively) low dollar values

And though more and more Mexican nationals are going to China for education and training, few Mexican companies know what to do with them upon their return to Mexico.

Perhaps the biggest problem Mexican companies face in China – and frankly, the same problem bedevils Chinese companies going abroad – is that they think they can operate overseas the same way they do at home. I still remember the first matter I handled with my company: a Mexican enterprise was operating in China, but had no idea about their legal status in China or whether they were operating legally. Everything from company formation to payroll had been delegated to their Chinese accountant, and as a result they had hired staff without any written contracts, they were not contributing to social insurance or housing funds, and they were paying everyone in cash. It was just a matter of time before they were found out and had the book thrown at them.

Finally, a nontrivial number of Mexicans (and some Chinese) consultants want Sino-Mexican relations to remain in this relatively primitive state, because this will allow these consultants to continue as “indispensable” founts of wisdom and knowledge in an uncertain world.

The one bright spot is the .02% of Mexican enterprises which are not SMEs. These enterprises are the huge multinational corporations known as multilatinas, and they are already operating in China as part of their global strategy. Some of them are already selling more goods in China than in the U.S., and to a one they plan to focus even more on the Middle Kingdom in the years to come. They would not be doing this if they weren’t already doing well in China. As global companies they consider themselves able to compete on the global stage, and you know what? They’re right.

In my concluding post, I’ll look to the future and specifically on how to improve the China-Mexico business relationship.

The above post is by Adrián Cisneros Aguilar. Adrian is the founder/CEO of Chevaya (驰亚), an Asia-Pacific internationalisation services company. Adrián has a Doctor of Laws from Shanghai Jiao Tong University and an LL.M. in International and Chinese Law from Wuhan University.

China and Mexico: The Two Amigos? Part III

Manufacturing in China: The Business Risks, Part 3

My first post in this three part series focused on a post entitled The 7 Major Risks You Run With Your China Manufacturers, by China manufacturing expert Renaud Anjouran. In that post, Renaud outlined the business risks foreign companies face when having Chinese factories manufacture their products. I noted how Renaud’s list nicely accords with what our China lawyers tell our clients who retain my law firm to draft their Chinese manufacturing contracts. See China Manufacturing Agreements: Binding Contract or Contract Terms. I noted how our manufacturing clients usually want to focus on a) intellectual property protection/prevention of counterfeiting, ownership of molds and tooling and after sales warranty service. In other words, the sorts of things legal agreements are really good at resolving. But oftentimes, core business issues like price, quantity, delivery date, quality and resolution of quality issues, subcontracting and shipping are of at least equal importance.

My second post focused on the first four items on Renaud’s China product outsourcing list. In this, my last post in this three-part series on China manufacturing, I focus on the last three items from Renaud’s list.

Risk Five: Subcontracting. Subcontracting of production presents a number of risks often not clearly understood by foreign buyers. Renaud identifies the first and most common risk. The foreign buyer goes to substantial effort to verify that the Chinese factory it has chosen is capable of meeting its quality standards. If the factory then subcontracts the foreign buyer’s product manufacturing to another factory, all of the buyer’s verification work becomes meaningless. This then leads to other issues: How will inspections take place? How will quality control standards be enforced? How will worker safety or worker age rules be enforced? How will anti-bribery and related rules be enforced? Working to the next level, manufacturing by a third party where there is no contractual relationship means that confidential information agreements are automatically breached, and this is a primary way intellectual property gets lost in China. Finally, molds and tooling are often moved to the subcontractor, resulting in loss of control and the inability to retrieve these items when required.

There are three reasons Chinese factories typically subcontract. First, the “factory” is a front for a trading company that actually does no actual manufacturing on its own. This type of trading company will subcontract all of the manufacturing and will limit its involvement to supervising (usually very poorly) the manufacturing process. Second, the factory may be capable of doing the basic manufacturing process, but it requires subcontracting assistance on key elements of the production process. For example, it is normal for Chinese factories to subcontract mold making and electroplating of key components. Finally, the factory may decide that the foreign

Manufacturing in China: The Business Risks, Part 3

Manufacturing in China: The Business Risks, Part 2

My first post in this two part series focus on a post entitled The 7 Major Risks You Run With Your China Manufacturers, by China manufacturing expert Renaud Anjouran. In that post, Renaud outlined the business risks foreign companies face when having Chinese factories manufacture their products. I noted how Renaud’s list nicely accords with what our China lawyers tell our clients who retain my law frim to draft their Chinese manufacturing contracts. See China Manufacturing Agreements: Binding Contract or Contract Terms. I noted how our manufacturing clients usually want to focus on a) intellectual property protection/prevention of counterfeiting, ownership of molds and tooling and after sales warranty service. In other words, the sorts of things legal agreements are really good at resolving. But oftentimes, core business issues like price, quantity, delivery date, quality and resolution of quality issues, subcontracting and shipping are of at least equal importance.

The source of the problems for Western companies that manufacture in China is the pervasive use of the purchase order approach to purchasing contract manufactured product from China. In China Manufacturing Agreements: Binding Contract or Contract Terms, I wrote how there are two basic ways to structure a China contract manufacturing agreement.

Option One is to enter into a legally binding contract (in Chinese!) that addresses all of the basic manufacturing issues. The agreement on price binds both the Chinese factory and the foreign buyer, and even if costs change, the parties remain obligated to pay and sell the product at the agreed-upon price, no matter which party benefits or loses from the changes. This sort of contract is common in much of the world, but less so in China. China, however, the entire risk tends to be loaded on one side or the other. The same applies to the other key business terms in China manufacturing agreements, such as the terms for payment, quantity, delivery date and quality. Foreign buyers who do not want to be bound or who cannot be bound due to lack of resources will follow Option Two. Under Option Two, the contract terms and conditions are binding on the parties only after a purchase order is presented by the foreign party and then accepted by the Chinese party. It is this lack of a binding agreement that is the primary cause of the seven manufacturing risks Renaud discusses in his post.

The obvious path to contract certainty  is to enter into an Option 1 manufacturing contract that formally commits both parties to the basic business terms for a specific period of time. However, the lure of China for many foreign buyers is that Chinese factories are willing to do small runs on a purchase order basis. The purchase order system is oftentimes THE reason why the foreign company is having its product developed and made in China. For this reason, our primary task as lawyers is to develop contract manufacturing agreements that deal up front with the risks that come from using the purchase order approach. Our job as China attorneys then is to make sure that our foreign buyer clients understand the risks and then to work on mitigating those risks in a practical way.

I explain below and in Part 3 of this series how our China manufacturing lawyers do that with each of the seven risks Renaud identified.

Risk 1: Lack of “Motivation.” The major risk we see stems from the foreign buyer loading the development costs onto the Chinese side with no incentive for the Chinese side to follow through on development. Renaud calls this risk “loss of motivation” and we see this all the time. The foreign side relies on the Chinese factory to do the product development, normally loading the cost on the Chinese factory. After two years, the development is not completed and the market has moved on, leaving the foreign side high and dry with no marketable product. The Chinese side assures the foreign buyer that they are “working on it,” but in fact the product development project is a low priority as compared to their ongoing manufacturing that pays their bills and so they are “working on it” only when times are slack. It is also common for Chinese factories to agree to take on a development project when they do not actually have the capability to do the work. In this situation, the delay results from the Chinese side being pushed up against the limits of what it can actually do.

The best way to address this lack of motivation risk basic method is to enter into a legally binding product development agreement with the Chinese factory that includes the following:

• Milestones: hard dates for development of prototypes or samples.
• Allocation of costs. If all costs are loaded on the Chinese side, the chance of success is dramatically reduced.
• A real incentive for the Chinese side to succeed. This incentive can be payments for the Chinese factory hitting its milestones or it can be a commitment to purchase reasonable (but predetermined) quantities of the developed product at a fair price.

Few foreign buyers follow this approach, with the predictable results described by Renaud.

Risk Two: Quality Failure at the Production Stage. The Chinese side agrees to manufacture the product at the “China Price.” Initial samples are acceptable in terms of quality, but once production starts, the quality is consistently bad. When pressed, the Chinese side says: “We gave you the China Price and you knew that at that price

Manufacturing in China: The Business Risks, Part 2

Donald Trump and Your China Business: Double Down, Ditch It or Die, Part 2

Last week I wrote a post on how our China lawyers have been receiving a steady onslaught of calls from American companies with “employees” or “independent contractors” in China, but no China business entity. The onslaught has continued, and now I know more about why.

China banks (owned by the Chinese government) are providing information to China’s tax authorities regarding account-holders who consistently receive money from foreign companies. China’s tax authorities are apparently going to these individuals and pressuring them into spilling the beans on why they are receiving their funds from overseas. Upon learning of a foreign (usually American) company that has “employees” or “independent contractors” in China, the Chinese government pounces.

If you are a foreign company operating in China without a China WFOE and you are trying to figure out what to do, your choices are relatively simple and stark.

But before I talk about your limited choices, I feel compelled to explain again why it is that so many foreign companies are still operating illegally in China. Chinese law limits hiring China-based employees to only Chinese legal entities. This means that if you are an American software company, you cannot hire someone in China to do your coding or to provide your support services. This means that if you are a Australian company selling widgets, you cannot hire someone in China to sell widgets for you. This means that if you are a British company that has your products manufactured in China, you cannot hire someone in China to do your quality control for you.

Any person (as opposed to a registered China business entity) performing employment-like services for you in China is your employee because China does not recognize independent contractors in anything other than extremely limited circumstances (and your circumstances do not qualify!). And Chinese law requires you pay both employer taxes and benefits on that employee. These employer taxes and benefits vary from city to city, but they usually total around 40 percent of an employee’s salary. China also mandates employers withhold around 15 percent of their China-based employees’ wages for individual income taxes. But those companies that do not realize they have employees in China are not doing that withholding either. Then on top of the employer and employee taxes, the foreign companies with employees in China are almost always going to be viewed by the Chinese tax authorities as “doing business in China” and that is because they almost always are. The foreign company is now almost certainly liable for having failed to pay its corporate taxes as well.

So when all is said and done, the foreign company owes a heck of a lot of taxes to the Chinese government, plus steep penalties, plus interest. Needless to say, the Chinese tax authorities salivate over collecting these taxes and interest and penalties.

In my previous post, I noted two common ways companies operating in China without an entity get caught:

One, we are hearing of long loyal “contractors” going to their employers and saying that if their employer does not double or triple their pay, they will report the foreign company to the Chinese authorities because their doing so will get them a tax amnesty (and perhaps even a portion of the taxes collected?). We are also hearing of vendors with whom the foreign company has no beef making essentially similar threats. Two, and most importantly, we are hearing that the Chinese government is poring over bank records and questioning people (your “employees”) who regularly receive funds unreported funds from overseas.

It is the second way of getting caught that is steeply rising.

What then should you do if you are right now operating in China without a Chinese company. You have essentially the following three choices:

1. You double-down in China by getting legal. Quickly, but very carefully. If you want to operate in China for the long term and you can afford to do so, you form a Chinese company, almost certainly a WFOE. For a flavor of what this involves, check out The NEW Steps for Forming a China WFOE. Note that it is not inexpensive to form a WFOE and if you do so you will need to start paying your employer taxes and you will need to start withholding your employee taxes and you will need to pay income taxes to the Chinese tax authorities on the income you earn in China. If you are going to choose this tact, you should do so immediately because in our experience, if you get caught before you even commence the process of forming your China WFOE, your chances of avoiding having to pay back taxes are slim to none. But if you can  at least get going on forming your China WFOE, your chances of avoiding having to pay back taxes are shockingly good. But not only should you get legal fast, you should get legal in a way that neither tips off the Chinese government about your previous (illegal and untaxed) activities in China and in a way that works for both your vendors and your “employees.” If just one of your vendors or “employees” believes that your China changes will make things worse for them, you are at great risk of being ratted out to the Chinese tax authorities and seeing your China operations collapse.
2. You ditch China entirely. If you either do not want to get legal in China or cannot afford to do so, your best course of action is to simply cease everything you are doing in China and leave. Doing this tends to anger vendors and “employees” and it certainly does not guarantee that you will always be safe from the Chinese tax authorities. So if you do this, we strongly recommend that neither you nor any of your foreign employees go to China for a long long time, preferably ever. For why this is so, check out How To Avoid Getting “Detained” in China and Why Your Odds are Worse than you Think. Both you and any of your foreign employees linked to your illegal operations in China are at risk both from your vendors/employees and from the Chinese government.
3. You make your stand and you die a slow (or a quick) death in China. A third option is to just keep doing what you have been doing in China and do it until caught and closed down. Just as with ditching China entirely, if you do this you and your foreign employees should not go to China again. The added risks of doing this are that your China vendors and employees may seek to take advantage of your situation. Here are some of the examples of this that we have seen:

• A vendor learns from one of your “employees” that you are not operating legally in China and uses the threat of informing on you to the government to raise prices.
• Your employees use the threat of your illegal operations to get an increase in salary. I know you are

Donald Trump and Your China Business: Double Down, Ditch It or Die, Part 2