Doing Business in China in 2023: Key Issues to Consider
Business for U.S. companies in China has become increasingly complicated. Laws and regulations on both sides of the Pacific are in a constant state of flux, targeting individuals, entities, and industries alike. Moreover, the lack of transparent rules and policies, or reliable economic and financial data can make even basic due diligence difficult, if not questionable with regard to the results. Stringent national security laws have resulted in headline-worthy dawn raids by Chinese authorities on the local operations of companies like Bain & Company and the Mintz Group.
Nevertheless, China still represents a huge market opportunity for many western businesses, as well as a reasonably sophisticated, lower cost option for manufacturing. If you are interested in exploring such opportunities, take time to consider the following key issues before making a commitment to the Chinese market for business expansion or establishing local operations.
1. Why China?
First and foremost, determine if China is the right market for your venture. In some situations, there may be suitable regional alternatives that will still provide the benefits, market access, and cost savings your company needs. For example, if your company relies on or is expanding into U.S. Government contracts, China may not be the right choice depending on the scope of proposed operations, but Laos, South Korea, or Taiwan may be worth considering as a regional hub (all of which are “Trade Agreement Act” designated countries and therefore their contributions are acceptable to the U.S. Government in qualifying tenders). Increasing restrictions on semiconductor exports and related materials and metals, both by China and the United States, may require you to consider alternatives for manufacturing or supply chain sourcing. Finally, new legislation entitled, “The Outbound Investment Transparency Act” (approved by the Senate on July 25, 2023), is currently making its way through Congress as a rider to the National Defense Authorization Act, which, if signed into law, may further regulate – if not restrict – investments and acquisitions in China (and other jurisdictions) in specified technology industries. A potential Executive Order from the White House targeting investments in China’s high technology industries is rumored to be in the works as well.
2. Invest in Due Diligence
Once you’ve decided on China, an investment in due diligence to help identify reliable, trustworthy partners and solid market opportunities is more than worthwhile
- Go to China Perhaps most importantly, travel to China (or send an employee on your behalf) to visit potential representatives and partners. Considering a substantive partnership agreement with a Chinese entity, or worse, beginning contract negotiations, without ever stepping foot in the country could be a recipe for failure. It’s worth the cost of the plane ticket and travel expenses to meet people, especially potential local representatives, contact the chamber of commerce, and simply experience Chinese culture, business culture and customs.
- Get a Local Representative Engaging both a good Chinese business representative and a good Chinese lawyer will be essential to your ability to conduct proper due diligence, and, should you find the right opportunity, to managing ongoing operations in-country. Unless you have internal staff who are professional-level fluent, your representatives need to be English-fluent, both conversationally and professionally, and have significant experience with U.S. business, as well as an in-depth knowledge of the local market and applicable laws and regulations.
Local representatives should be able to advise you on the type of operation you require – such as a wholly-owned foreign entity, branch office, joint venture, or arms-length independent contractor, and help to identify target opportunities and the right physical location in China based on your specific needs, potential market activities, regional industry centers, and available incentives. Tianjin, for example, is the largest port in Northern China and is a center for mechanics and textiles; while Qingdao is a hub for biopharmaceuticals, electronics, and chemicals, and is a vital harbor city with significant access domestic markets.
3. Regulatory Considerations & Compliance
Understanding regulatory considerations and compliance obligations before entering new business relationships in China, as well as ongoing monitoring of developing rules, rulemakings, and edicts or executive orders both in the United States and in China, is also critically important to ensuring successful business operations. At a minimum, the following key areas should be reviewed:
- Export Controls U.S. export control laws and regulations, both the International Trafficking in Arms Regulations (“ITAR”) and the Export Administration Regulations (“EAR”) are important considerations when sending goods, software, data, know-how, and technical information to China. A thorough review of your company’s technology to determine licensing and related requirements is essential if technology transfer will be part of your business model. This analysis includes not only U.S.-origin technology, but also foreign technology transiting through the U.S. The U.S. Government also maintains, and regularly updates, a list of parties, individuals, government departments, and business entities to whom exports are forbidden. Accordingly, incorporating regular review of these lists prior to export will be beneficial to determine if the end user or consignee in China is permitted. Violations of export controls may carry both civil and criminal penalties, and result in debarment from export rights for a period of time.
- Sanctions The Office of Foreign Assets Control in the U.S. Treasury Department (“OFAC”) manages and enforces sanctions regulations. While there are no blanket sanctions preventing trade with China, such as the sanctions on Iran and North Korea, OFAC did issue sanctions in 2022, pursuant to an Executive Order of the President, severely restricting trade and investment with Chinese companies owned by the PRC military industrial complex. Due to the complexity of due diligence and lack of transparency in information access, it is often difficult to determine the extent to which the Chinese military may own or control “private” entities in China. Like export control violations, sanctions violations may carry both civil and criminal penalties, and result in debarment from export rights for a period of time.
- Anti-Bribery and Corruption Both the U.S. and China have statutory laws against bribery and corruption. In the U.S., the primary law is the Foreign Corrupt Practices Act. In China, it is the Anti-Unfair Competition Law, and corresponding criminal statutes against bribery. While Premier Xi Jinping made a tremendous public display of combatting corruption in China, the laws are not enforced consistently. “Guanxi” (loosely translated as “relationship building” or the practice of giving gifts, if not outright bribes, to curry favor or develop influence and cultivate business relationships) is still widespread. Care must be taken not only in the due diligence process when identifying partners, but also the implementation of antibribery policies, programs, and training, with local Chinese partners once they are under contract.
- Additional Regulatory Concerns Understanding applicable industry regulations, such as those for the telecommunications and pharmaceuticals sectors, will be essential to your due diligence and ongoing compliance efforts, depending on the nature of your business. Additional rules governing conflict minerals, slave labor, and other humanitarian matters may also apply and are no less important.
- PRC Laws Partly to protect domestic industry and national security, and partly in retaliation to increasing U.S.-imposed trade restrictions, China recently promulgated new controls and limitations on U.S. and Western businesses. A recent example is China’s new restriction on the export of certain rare earth metals, critical to the semiconductor industry (gallium and germanium-based metals), which take effect August 1, 2023. More restrictions are possible, if not probable, should the trade conflict continue.
4. Protect Intellectual Property
Intellectual property protection is a significant concern for technology and consumer goods companies doing business in China. IP concerns, along with national security interests, have been a major motivating force behind the increase in trade restrictions and retaliatory measures, respectively, on both sides. Knock-offs of Western products and software are abundant.
Prior to entering the Chinese market, a company should consider reviewing its patent, copyright, and trademark portfolio to determine what IP should be registered in China to secure protection. Ideally, this question should be considered at the initial US IP registration phase, that is, in what other countries and markets will it be beneficial to obtain IP registration and protection.
In addition to government-sanctioned protection important contractual and operational protections are necessary to protect trade secrets and other proprietary information ineligible or unadvisable for registration. Although commonly used in the U.S. and Western markets, traditional nondisclosure agreements are insufficient. Rather, an “NNN Agreement” – non-disclosure, non-use, and non-circumvention agreement adds further protections beneficial to protecting your interests in the local market.
The NNN Agreement expressly limits how a company’s IP may be used. Liquidated damages provisions are common and are beneficial. NNN Agreements are recommended as an integral part of your contractual framework with OEMs, distributors and local representatives, and even joint venture partners.
5. Understand Contract Limitations
Although contracts play a significant role in U.S. business relationships, their value will depend wholly on the trust and reliability you are able to place in your local Chinese partner. Such a principle is not unique to doing business in China, but certainly takes on additional significance in light of the cultural and political differences that exist between both countries. Therefore, while writing a solid contract is important, due diligence can matter even more.
In closing, despite increasing tensions between governments, complex regulatory systems on both sides, and the inherent risks, both the size of the Chinese market and the country’s technical and manufacturing sophistication cannot be dismissed. With the right local representation, provided careful planning additional measures, such as outlined above, China represents a promising opportunity for many companies, both large and small. If you would like to discuss a potential business opportunity in China, or any of the issues discussed here, please contact Michael Mendelson at email@example.com or (202) 596-6610.
Michael Mendelson is a Partner with OGC and brings over 25 years of legal and business experience to his clients. He regularly handles a broad variety of matters for established and start-up clients, including complex international transactions, international trade compliance, M&A, early stage financing, government contracts, and commercial contracts.
This publication should not be construed as legal advice or a legal opinion on any specific facts or circumstances not an offer to represent you. It is not intended to create, and receipt does not constitute, an attorney-client relationship. The contents are intended for general informational purposes only, and you are urged to consult your attorney concerning any particular situation and any specific legal questions you may have. Pursuant to applicable rules of professional conduct, portions of this publication may constitute Attorney Advertising.