CHINA ESQUIRE

Right when I finally post something somewhat negative about the health of the Chinese economy, another news piece goes ahead and tells us what we probably don’t want to hear: that some of the explosive growth (a bubble?) that we had been expecting is slowing down. The International Herald Tribute published an article called “ Tough Times for Chinese IPOs” ( h/t to China Digital Times) and had this to say:

When stocks in three big Chinese companies sank below their initial public offering prices last week, investors who bought shares in last year’s offers suffered. China’s once-roaring IPO market is another casualty.

After spectacular growth last year, when mainland China eclipsed the United States as the world’s biggest market for initial public offers of equity, sliding stock prices and concern about oversupply threaten to stifle activity this year.

“The bubble is bursting after rampant speculation pushed prices of newly listed shares to ridiculously high levels at the peak of China’s stock bull run late last year,” said Zheng Weigang, head of research at Shanghai Securities. “This will slow equity fund-raising in coming months and deter the overpricing of new offers and new listings.”

The IPO flood, in which deals were greatly oversubscribed by investors, appeared to be a major achievement of China’s financial reforms, for the first time making the stock market an important source of funding for many companies.

But a collapse of confidence, due to factors including slowing corporate profit growth and plans for huge cash calls by listed companies, has sent the main Shanghai index plunging more than 40 percent below October’s record peak. That plunge led to a virtual halt in IPOs in March; the only one was the $53 million sale by Fujian Fujing Casttech, a maker of laser equipment. By contrast, five companies raised $300 million in March last year.

But a lack of big offers in the pipeline means that China’s IPO activity this year will shrink substantially from 2007.

Last year, the market expected several of China’s big Hong Kong-listed “red chips,” like China Mobile, to list in Shanghai in 2008. That now looks unlikely.

Shares in three large companies - China Shipping Container Lines, China Coal Energy and China Pacific Insurance - have fallen substantially below the prices of their IPOs. They were the first major stocks to do so since the ban on offers was lifted.

Even after IPO activity picks up, offerings will be priced more conservatively and enjoy smaller increases on listing day, analysts predicted.

Where do I begin? I have publicly stated that I didn’t think this would be the year that some of the Chinese stock market bubble would burst. I had been thinking that it was 2009. But if IPO’s are no longer the much-hyped events that they used to be, that means one of two things: (1) that the bubble will not burst because corrections are starting to happen already. There will be no need for a large scale decline as long as little declines are happening. (2) That the bubble is already starting to burst and we will see a decline or even a freefall from this point forward. (3) a combination of the two: things haven’t gone to hell in a handbasket quite yet, but it will later.

I am not an economist–I am an attorney. (which was some of the source of chagrin for Dan Harris at CLB given the scope of events happening in China that are not law related) While I am not afraid to venture out, this sort of prediction is not within my reason at all, so I won’t care to speculate on this.

What I am concerned about is this: lower valuations and decreasing IPOs is rather reminiscent of the first signs of some sort of slow down. And that spells bad news for the service professionals who thrive on IPOs: i-bankers, accountants, and lawyers. If valuations are less, companies will be more hesitant to go public. There is possibility of a downward trend. Which should make Chinese service professionals wary. Are we talking layoffs? I don’t know, and I sure hope not. Are we talking less work to go around? Likely, which means competition to do the deals that people didn’t want one or two years ago will grow.

Much of this is speculation at this point, but it doesn’t hurt to sound the alert for Chinese related service professionals: it may be time to tighten your belts and compete.

UPDATE: Jack Perkowski at Managing the Dragon had a post entitled “ The Sounds of Bubbles Bursting” where he talks about how there are signs of the economy slowing.  Here are some excerpts:

“This place has bubble written all over it.”

You don’t have to be a finance professor to come to the same conclusion. Signs are everywhere—from an inflated stock market, to growing inflation to ever increasing apartment prices. The questions are: Does China have a hard or soft landing, and what does it feel like? What happens after the Olympics?

All of this suggests an economy which will begin to slow, if it has not already. What the rest of 2008 brings, and whether the inevitable emotional letdown after the Olympics has an economic impact, is anyone’s guess.

The weekend is here, and I guess that means its review time. It’s becoming customary here and I didn’t see a reason to buck the trend. I saw this article yesterday from Asia Times Online that notes that China’s banks are too cautious now with a bear market mentality. ( h/t to China Digital Times) Here are some excerpts:

When over 80 years of Wall Street history came to a crashing end with the demise of Bear Stearns on March 17, the shock waves of bankruptcy reached as far as Xinyuan Nanlu, Beijing. There, on the 9th floor of the Capital Mansion building, executives of CITIC Group immediately decided that there was no point in throwing good money after bad.

In October 2007, CITIC Securities, a brokerage controlled by CITIC Group, and US investment bank Bear Stearns had agreed a seemingly visionary mutual shareholding deal. Under the terms of the agreement, CITIC Securities would have taken a 6% stake in Bear Stearns for about US$1 billion, while the latter would in turn have taken a 2% stake in CITIC Securities, also valued at $1 billion.

Five months later, things looked a little different for Bear Stearns following misjudged subprime market adventures and facing a lack of liquidity. JP Morgan Chase, aided by the US Federal Reserve, was bound to fetch the whole of Bear Stearns for a mere $236 million in a speedily arranged fire sale that implied paper losses of about $985 million for CITIC Securities if its own deal with the Americans had gone ahead as scheduled. As sensible bankers, CITIC’s leaders went for the natural solution, balked at the investment and pulled out of the negotiations.

What could appear as an isolated tale of a merger and acquisition (M&A)deal gone bad might yet spell greater significance for the future evolutionary course of China’s financial markets.

In a natural extension of China’s changing approach to regulating its financial sector, the country’s largest financial institutions in the 21st century also started venturing abroad in their quest to tap into new growth areas. Consequently, with war chests bulging from their initial public offerings and/or China’s massive foreign exchange reserves, in 2007 alone Chinese financial institutions acquired equity stakes in Britain’s Barclays (China Development Bank), South Africa’s Standard Bank (Industrial and Commercial Bank of China), Belgian-Dutch financial group Fortis (Ping An) and US private equity group Blackstone (China Investment Corp).

CITIC Securities’ move for Bear Stearns also fell into this category of business line expansion coupled with increasing geographical reach. The deal’s dramatic cancellation as well as problems with other such ventures (the investments in Barclays and Blackstone have led to significant losses for the Chinese side) may induce renewed caution on behalf of Chinese policy-makers, regulators and bankers when it comes to loosening the rules governing the permissible business scope of the country’s financial institutions.

The fact that the pernicious effects of the subprime crisis will be around for a while only adds to this new cautious attitude. While caution is definitely in order in the brave new world of securitisation finance, a return to the world of rigid financial sector compartmentalization would not be in the best interest of China and the global financial system.

For one, unnecessarily strict regulation would make it harder and more expensive for Chinese firms and consumers to satisfy their increasingly sophisticated financial needs. At the same time, Western banks and securities firms are in greater need than ever of capital infusions from countries with savings to spare. Let’s hope it takes more than a wounded bear to scare off a dragon.

This is a total shame because we all know that China has a lot of money rolling around in its warchest.

Why is this important? Because I had thought that China and its attempts to inject its capital into foreign holdings and stakes in MNC’s would be taking off by now. Not that it isn’t happening, but seeing that China is becoming cautious is a bit unnerving for lawyers. It means less foreign investment, and therefore, less work to do for lawyers. I thought that the reverse M&A market and other types of corporate transactions would take off due to China’s new-found aggressiveness. (see here) Perhaps I was wrong. I hope I am not, and so for now, let’s hope that China continues to flex its financial muscles a little bit more.

I just couldn’t resist the title. Everyone’s a winner at Nixon Peabody, even in China. Or more specifically, Shanghai. (Don’t worry, I won’t host any mp3 of the song, I will just link to it in case you haven’t heard it.) But here is yesterday’s news from The Recorder entitled “ Nixon Goes to China” and states that Nixon Peabody is opening up shop in China:

Nixon Peabody has announced that it has opened up an office in China. The office, based in Shanghai, is currently staffed with two attorneys on a rotational basis, but the firm has plans to hire more attorneys in the near future. The two lead partners are James Chapman from Palo Alto, Calif., and Daniel Deshon from San Francisco.

The impetus for the office is, of course, client-related. Nixon Peabody already has a China practice, which includes 14 partners who advise clients on venture capital and private equity investments in China, on business and trade issues, and on intellectual property rights. Having an office in the country helps to facilitate those matters.

The new Shanghai establishment is the firm’s first office in China, and the second international shop. The first opened in London last year.

I think this is the third large firm in less than 3 months wanting to do business in China now, so it’s only a matter of time before your biglaw firm (if it has a corporate and international practice) will want its own China office. But for today, Nixon Peabody is the winner…

Charlie McElwee posted the other day about the Ministry of Environmental Protection ( MEP), and what the new head of the MEP has been saying. I thought it interesting but wanted to think about it for a day or two before I made any comments. His post:

The new Minister of the Ministry of Environmental Protection, who was the old Minister of SEPA, Zhou Shengxian, announced yesterday that setting up a law enforcement system of “iron and steel” is at the top of his agenda. A China Daily article reports as follows:

“The new ministry will have greater authority to crack down on environmental crime, and we will expand our enforcement and surveillance teams,” he said.

Regular meetings, and joint enforcement, surveillance and information sharing systems will be set up not only among environmental protection departments of all levels, but also with law enforcement and judicial bodies, Zhou said.

I’m not sure where the new authority Minister Zhou refers to is coming from, but the words are encouraging.

I would agree that this could be very encouraging news: the new MEP is ready to crack down on environmental crimes. And note in the article that Zhou Shengxian did say he wanted to work with judicial bodies. This means that China is about to get serious about environmental regulation and law.

I think China’s new candor about its environmental needs and policy is a breath of fresh air. For example, the government officials in charge of the Three Gorges Dam finally admitted that this dam has the potential for environmental disaster. (see article here, h/t to CDT) I think this sort of candor will help fuel the rise of environmental regulation in China. The laws have been on the books, but now it seems like there are governmental directives to clean up China’s environment.

So is the rule of law about to grow through this new-found initiative? Maybe. If China cracks down on violators equally, then I think the rule of law will grow through this. Improved enforcement and applied at all levels, especially against Chinese companies, will help people learn to respect the law and submit to it. And hopefully in the long run, appreciate it too.

Why am I skeptical? Because China’s enforcement, aside from some enforcement against Chinese companies like SEPA’s interference with companies trying to go public and have their IPO’s, has largely targeted foreign companies for environmental violations and crimes. Yes, it is unfair. But unfortunately, that’s the track record so far. If China continues to do this, then I am not sure rule of law will get very far though the MEP stance is encouraging and sounds good. China must crack down on both foreign and domestic companies if its wants to get anywhere: both in the rule of law context, and also trying to curb environmental problems down the line. It is the only way.

Will China do it? Maybe not. But for your clients, the foreign MNC’s who have Chinese operations, make sure that you are complying with all environmental regulations. I have a feeling that if you do not, this new motivated MEP will be knocking on your door.

UPDATE: Charlie added some more about MEP enforcement here.  This actually may be worth another post on my part over the weekend…

Will Lewis added me to his blogroll, having said this about the blog:

Tom Chow, Associate Attorney at Gartenberg Gelfland Wasson & Selden with “practices in the areas of international business transactions, corporate law, intellectual property and general business litigation,” is a prolific poster on, well, exactly what his tagline says: “Chinese law, business, and society… and anything else remotely interesting. A solid recent post: growth of e-commerce means growth opportunities for lawyers.

Will has commented here before, and I have appreciated each of the comments thus far.  I haven’t added him to the my blogroll, which is probably long overdue now.  Without further adieu, Experience Not Logic is now part of the rolls.

The California State Bar International Law Section is co-hosting an event with the International Centre for Dispute Resolution: the third annual California International Arbitration Conference. This year’s title is “Decision 2008 - Debates on International Arbitration”. It is scheduled for Friday, May 2, 2008, from 8:30am - 5:15pm, and will be at The Doubletree Guest Suites in Santa Monica, CA.

Here is a little about the program:

The arbitration of disputes arising from cross-border transactions and relationships is a highly topical issue, having engendered in recent years significant discussion in the secondary sources. Moreover, entertainment disputes often involve questions of intellectual-property and technology law that remain of interest to virtually every California practitioner from San Diego to Silicon Valley, and to Hollywood inbetween. The 2008 conference will address each of these key areas of international arbitration practice.

Last year’s conference, which focused on the resolution of disputes in the Pacific Rim, succeeded in bringing together some of the world’s leading practitioners from China, Japan, Singapore, Canada, the United Kingdom, and, of course, the United States. This year’s diverse and equally distinguished faculty, which will include key industry representatives as well as preeminent practitioners, will provide attendees with insight into trends and developments in international arbitral law generally and into the resolution of international entertainment disputes in particular.

And the keynote presentations from the program are:

Session I: Star Wars – Whether to Arbitrate or Litigate International Disputes

So-called entertainment disputes in reality cover a wide range of areas, from talent contracts to real property transactions to film financing agreements. This panel of experts will address the costs and benefits of moving international commercial disputes and entertainment disputes, to the extent such things exist, from national court systems to international arbitral bodies.

Session II: Hollywood to Bollywood – Arbitration Means Different Things to Different People

The second panel will consider whether advocacy and decision making styles differ from continentto- continent or even from country-to-country, identify perceived differences, and debate which styles may be most effective in an international arbitration proceeding.

Session III: Copycat – How to Protect Your IP Overseas

Effectively protecting copyrights, trademarks, trade secrets, and patents can prove difficult under the best of circumstances and becomes all the more challenging when that intellectual property takes its way across borders. The third session will consider the role international arbitration can play in meeting that challenge, addressing, among other things, the arbitrability of intellectual property disputes, the availability of interim measures in arbitration, and the enforceability of IP related arbitral awards.

Session IV: The Big Fix – Problems and Ethical Challenges In International Arbitration

The fourth and final session of the 2008 California Arbitration Conference will address potential improvements to the current systems of international dispute resolution in the areas of arbitrator ethics, conflicts of interest, discovery, non-signatory involvement, confidentiality, and case management issues.

The list of speakers includes attorneys and mediators from the U.S., Canada, China, Japan, Singapore, India. Brochure for the program is here, and you can register here. The program is also worth 6.5 hours of MCLE credit.

The lunch session is actually being by Kenneth Starr, former Judge of the United States Court of Appeals for the D.C. Circuit, former Solicitor General of the United States, current Dean of Pepperdine Law School, and author of the infamous Starr Report from the Whitewater days. Should be interesting… and perhaps even entertaining.

Chris Devonshire-Ellis was kind enough to send me some books from China Briefing, and so I guess I owe him a favor. Just kidding. Really, there is no “favor” or “guanxi” sort of thing going on. He sent me some books because of my blogging interest, and instead of reading the technical ones first (on WFOEs, JVs, and M&A), I decided to read the fun one, “A Story of a China Practice” which details the story of his tax firm in China.

I found the book to be interesting just because real life experiences tend to be. (at least, far more interesting than reading law casebooks, which is only fun when judges have a sense of humor) He starts out his story by talking about how he had no clients for a year and a half, living off of almost nothing, and then he got his first job doing a trademark for a local expat bar. He then moves onto discussions about how he ended up finding work here and there (some trademark, setting up representative offices), to the point where he hired two local gals from a bar to be his assistants/associates and set up his first office in his apartment. And then he talks about down times. He talks about how his business almost folded with the Asian Economic crisis in the late 1990’s, and how he couldn’t pay some of his staff on time. He talks about various staffers who ended up cheating the company and causing trouble. Fast forward 15 years, and he has multiple offices, a number of publications, and 2 equity partners. (and a lot more drinking stories)

What it is not: a professionally edited publication. So yes, there are grammar and spelling typos. Nor is it a manual for doing business in China. It’s just a story. So don’t confuse this as a technical guide or Pulitzer quality novel. What it is: a good, mindless way to relax.

Key lessons, which actually don’t apply just to China business, but more to any business (not Chris’ lessons, but just some of my thoughts after reading):

• Expect the worst to happen. He had staffers cheat him by stealing petty cash, using their position to import vehicles illegally, his business almost folded with excessive advertising contracts, etc. Expect it. I know that many people who start a company (not just in China, though this definitely applies to the people who think setting up in China = instant success) don’t ever consider what happens if you fail. Or if things go wrong. Well, any good business is going to have to weather the storms that come with doing business. So always be ready for the worst. Firms that survive do so through ups and downs.
• Hire good staff. Loyal staff if possible. And then hold onto them. Chris Devonshire-Ellis knew that he wasn’t the best of administrators, and acknowledged it openly. And so he brought in a couple of people (soon to be his partners) who were. And they stayed through the ups and downs, even with personality conflicts (e.g., Alice and Sabrina).
• Keep up a good image. DSA moved into nice offices–perhaps even more swank than justified. (In fact, this is what Susman Godfrey has been doing all along in the United States) Why? It makes your staff feel important. It makes you look powerful and able and intelligent. It makes your clients feel at ease when they think they have hired the best. Even in business here, image isn’t everything… it’s just maybe about 75% of it. Okay, maybe 50%. But its a lot. How much more in China?
• The Chinese mentality is different than the Western mentality. I think that’s a given. And though Chris never says it is so, you can tell that it is quite different when you read the book. So don’t expect your clients or staffers to behave like good ex-pats or Western-trained workers. Because they often aren’t. China Solved has a lot of good articles on dealing with Chinese employees, and I highly suggest reading those as well.
• Be flexible. Innovate as you need to. Learn new skills as you need to. I don’t think this needs much explanation.

Yes, none of this is rocket science. It’s business–which I believe is more an art than a science.

Note: I know of the controversies around Dezan Shira & Associates, but this is a friendly book review. Please keep comments in line as I tend to not moderate comments, but will exercise that role here as necessary. This blog will not become a battle ground. Thank you.

UPDATE: Bill Dodson and I must be drinking the same kool-aid. He has a book review today on this as well. A fun read.

CNN Money apparently did.  Just be glad that you or your child didn’t find one of these.

Yet another China products safety article, this time focusing on camouflaged eggs and spinning egg top toys. Right in time for Easter. The very brief article entitled “Easter egg toys recalled” states:

About 13,000 camouflage eggs and spinning egg top toys, imported by Hobby Lobby Stores Inc. and made in China, because the paint on the toys contains high levels of lead, which is toxic if ingested by children.

No injuries or incidents have been reported. The recalled products include the Camouflage Easter Egg Treat Containers, with the item No. 1031, and the Easter Spinning Egg Tops, with the item No. 1054.

They were sold at Hobby Lobby Stores nationwide from January 2008 through this month.

For more information, visit http://www.HobbyLobby.com or http://www.cpsc.gov.

Just another reminder that periodict and/or constant QC and follow up, coupled with due diligence, are your best friends to avoid embarassment, civil liability, or even worse, criminal liability.

Happy Easter everyone!

The AFP recently ran an article about the growth of e-commerce in China, arguing that it is “gaining a foothold” in China. Well, I suppose that could be a true statement if you compare it to the fact that there really wasn’t much going on before. But that being said, the first thing I thought was that e-commerce still had a very long way to go before it becomes as accepted as in the U.S. (though it was not that long ago… maybe 10 years ago that many of my friends remarked, “I will never buy anything online because it’s just not secure enough.” How things have changed.) The second is that this will present lawyers/businesses with many new opportunities in the future.

The article states ( h/t to China Digital Times… and yes, I know China Venture News ran it yesterday, I actually scheduled this post before they ran it):

With more Internet users than any other nation on the planet, China’s e-commerce is booming, but obstacles remain before the full business potential can be unleashed, analysts said.

China’s online population is now at 220 million, Beijing-based research firm BDA China said late last week, overtaking the United States as the world’s number one, highlighting the growth opportunities in the huge Asian market.

Fifty-five million of China’s Internet users shopped online last year for a total turnover of 59.4 billion yuan (8.25 billion dollars), according to the China Internet Research Centre in Beijing.

That is up from 43 million online shoppers in 2006, when the value of transactions stood at 4.3 billion dollars, the centre said — and an even larger jump from the 62 million dollars spent online in 2000.

By 2011, the centre projected that online spending will hit 406 billion yuan as more of China’s Internet users turn to online shopping.

Yet the level of online spending remains modest: about 1,000 yuan last year per consumer, or 0.64 percent of total retail spending in China.

Growth in its e-commerce has lagged due to consumer concerns about reliable online payment methods and counterfeit goods.

“I’m still shopping in town more than on the Internet. I just don’t completely trust Internet shops,” said Lin Yue, 24, a businesswoman in Shanghai.

According to the centre Lin’s concerns are well founded. “The purchasing of fake goods, credit card theft and other related problems emerge in an endless stream,” it said.

Another challenge that Internet companies in China face is the small number of credit card users, with 75 million credit cards in circulation by the end of 2007, according to state media reports.

Although credit cards are becoming more popular, Liu said their still low penetration rate along with quality controls and infrastructure issues explain why online sales in China last year made up little more than six percent of that in the United States.

First off, I make the observation that within the last year, despite the rather low level of online spending, the growth of spending did double. I don’t think this will be a fluke either. In fact, once e-commerce actually becomes reliable in China, I would expect the people in major cities like Beijing and Shanghai coming to rely more heavily on it. So expect even heavier growth than this.

Second, the law in this area needs a lot of development, which is where lawyers can come in. (though I think more for policy folks than for the transactional folks) But the article already hints at the problems with e-commerce: IP infringement/counterfeiting, credit card theft, and lack of payment methods. Let me add some: privacy of information and internet security (yes, that’s a business issue).

Before e-commerce can take off, IPR enforcement will have to grow. It’s just a matter of fact: intellectual property needs protection before consumers can trust products. I don’t need to preach on this issue at length, I am sure its been done time and time again. But if people cannot trust e-tailers, it will slow the growth of internet sales drastically. Which means growth opportunities for lawyers doing IPR work in China. (and from what a colleague has told me, a good chunk of IP enforcement is not just lawyer work… it’s also doing factory raids and such)

Credit card theft/financial privacy is an obvious area. Chinese lawyers will need to take the lead to write good and enforceable laws that govern the area of internet transactions. (which strengthens the idea that more lawyers in the Chinese Parliament is a good thing) The U.S. has so many privacy laws. For financial institutions there is the Graham-Leach-Bliley Act (not to mention California’s even more stringent version), and a lot more. (there is even a consumer protection law that makes it illegal to show more than 4 digits of a credit card number on a receipt!) Which means that Chinese lawyers, congressional folks, and law professors will have an opportunity to weigh in on these issues. Not to mention Chinese business lawyers having to write lengthy “Terms and Conditions” pages for internet businesses.

And for credit cards, that is yet another area where Chinese business lawyers can have a field day. Drafting long contracts for credit card agreements, writing disclosures as needed, working on banking laws… I know that China has begun to allow foreign banks like HSBC to incorporate locally and issue credit cards. It will be a boon to foreign banks, and therefore, business lawyers.

I think you get the point. This is a good thing for business lawyers, policy lawyers, etc.

Despite all of the hubbub about Tibet (which is important news, don’t get me wrong), the headline that caught my eye fastest yesterday at China Digital Times was that the Heparin contaminant was actually identified.  Here is the article from the Los Angeles Times ( h/t to CDT):

A compound related to a common nutritional supplement has been identified as the contaminant in a blood-thinning drug imported from China that sickened hundreds of frail patients in the U.S. and is suspected in a number of deaths, federal officials said Wednesday.

The substance mimics the real drug — heparin — in standard safety tests and may have been deliberately substituted for the genuine compound somewhere along the line to boost middlemen’s profits. It could also have been added through a mishap or some kind of misguided experiment. Because of difficulties in back-checking, it’s unclear whether Food and Drug Administration officials will ever know for sure.

The recall inflamed public concerns about the safety of consumer goods from China; the heparin investigation may give a boost to legislation stalled in Congress that would set up a much more rigorous import inspection system.

“It is unacceptable that Americans have died and been seriously injured by what appears to be deliberate tampering,” Sen. Edward M. Kennedy (D-Mass.), who chairs a panel that oversees the FDA, said in a statement. “Whether this contaminant was introduced intentionally or by accident, the full force of the law must be brought to bear to bring those responsible to justice.

“To guard against future abuses, every drug manufacturer needs to inform FDA of where it sources its ingredients and what it is doing to ensure that these ingredients are pure and potent.”

“This is not a new problem,” said England, who now advises foreign companies on how to comply with U.S. regulations. “This is a close cousin of problems that have presented themselves before.”

The FDA is chronically short of resources to meet its mandate to oversee a vast array of drugs, medical devices, and processed and natural foods. Inspections of foreign producers in particular are infrequent. And China has been difficult territory for U.S. regulators.

I have already been on the record many times about doing QC and due diligence with regards to the Heparin debacle, so I will refrain from overly beating a dead horse.  (see “ first pet food, then trader joe’s, now heparin…” and “ heparin update part 2: chinese fda lays responsibility on importers“)  Note that the FDA cannot catch all of the bad apples. It is short of resources–in fact, woefully short of resources.  So if you are counting on regulatory agencies to help solve your sourcing quality issues, the U.S. has no resources and the Chinese have disclaimed all responsibility.  In other words, the ball is in your court.  ‘Nuff said.

The other thing that I want to note is that Senator Kennedy is on the record saying “the full force of the law must be brought to bear to bring those responsible to justice.”  Well, if the LA City Attorney’s Office can do it, so can others.  We now have a Heparin contaminant identified.  As the article points out, we may never know where the problematic materials were introduced.  So who will take the fall?  The FDA won’t. I foresee yet another criminal case coming in the future.  Maybe not now, but if deadly toothpaste and pet food can warrant a criminal case, you can be sure this Heparin thing will too.  I don’t know if it will be Baxter or someone else, but just wait and see.  It may even be a different set of charges because this criminal liability thing for Chinese sourced products is so new that prosecutors have room to be creative in which causes of action to bring.

The storm is coming.  Do you feel it?

Rich Brubaker at All Roads Lead to China made an interesting post yesterday that I think deserves some comment, especially in light of my stance towards a buyer’s responsibility and the new criminal liability cases that have been filed against companies dealing with China imported products.

He writes (emphasis added):

Last summer, then Lead pain Barbie and Toxic Tommy the Tank were all the rage, and popular media was focused on the role of governments in trade, I was hammering away at fact that the ultimate responsibility for assuring quality rests solely with companies. sure, government agencies, standards, and advocacy groups play a role, but this summer highlighted that what was really missing from the equation was good old fashioned common sense quality control and assurance leadership.

Now.. I want to take this a bit further, and highlight the fact that through all of this, there is probably no more important person in this equation that the buyer. typically the person that identifies potential suppliers, the person responsible for developing the RFQ, responsible for developing the assessment framework for the program, and the person whose opinion/ expertise will provide the greatest amount of weight when CEOs/ Directors make final decisions, the buyer role carries a huge amount of responsibility.. and it is here that I am afraid that we are a bit lost… and it is here that I think the greatest room for change can occur.

and when I see that firms like Disney are still.. STILL … having labor problems that are really elementary in China, I get pretty burned because they are having problems for no good reason other than trying to “save” money… but more than Disney, or McDonald’s who is again.. AGAIN.. in trouble for failing to pay their staff properly, we are starting to see that the failures that occur at the supplier level could have been prevented if the buyer had invested more fully into the system that they are seeking to exploit.

One of the most interesting cases that I can point you towards is the just released Nike study of their own suppliers where readers are given what I think is the best window into the problems.. and some of the solutions.

Unforuntaltely, in the world of textile, take denim for example, you will have a buyer send out a RFP with samples to 30 potential suppliers. there is little or no ownership in the process, and essentially a reverse auction process begins where bidders will win if the have the best lead times… and more importantly the best pricing. It is a process that many in the industry is known to create/ promote poor working conditions at poor pay.

Where buyers are important in this picture is that they hold all the cards. Prior to closing a deal, it is their inspection of a factory that provides the basis for future RFQs, and were they to begin considering the social aspects of the process, perhaps factories would be forced into cleaning up. When problems do arise, it is also the buyer (not the social auditor) who would have the most power in addressing the problems constructively.

I have no doubts that buyers are in the best position to ferret out and deal with problematic factories, quality fade, unsafe products, etc. No one else is going to take the blame for the buyer/importer who actually brings this stuff into the U.S. and other foreign nations. Sure, there is always a Chinese factory to blame. But guess who is in the best position to do QC and due diligence? The buyer. This was something that Rich stated in his first paragraph, which I had to emphasize. If you cannot do your own diligence and QC, then hire an able third party consultant who can!

Unfortunately, it isn’t just common sense that will enforce these ideas. It is the lawsuits. If you happen to import something deadly, expect it. Plaintiff’s lawyers love these headlines because it means there will be a payday for some of them. (disclosure: I once summered for a nationally prominent plaintiff’s side lawfirm) But even worse, we now have 2 cases where criminal liability ( pet food and toothpaste) was charged against companies importing dangerous products.

This means that you as the buyer/importer have the responsibility whether you like it or not. I wish I could say otherwise, but that’s the reality of the situation.

Whereas Rich is saying that common sense means you need to be careful about your business, I am saying that it is both common sense and liability for civil and criminal lawsuits that should make you careful about your business.

Most of the China law blogs have been highlighting debates about what sort of entity (wholly foreign owned entity or joint venture, see e.g.) to form when your American or European clients decide to enter China–whether to market to the Chinese, find a new supplier in China, set up a factory in a 2nd tier city, etc. But CNN ran an interesting article yesterday that focuses on Chinese investment coming to set up shop in the U.S. and other places. In other words, the exact opposite.

The article reads ( h/t to CDT):

Amid the torrent of clothes, electronics and toys surging out of China comes a little-noticed export: international companies.

For centuries, individual Chinese have sought their fortunes abroad, creating Chinatowns around their restaurants and shops. Now, Chinese firms are going global, pushed by a government turned capitalist, pulled by untapped markets and armed with bundles of money from a thriving economy back home.

Auto plants are popping up in Latin America. A sprawling commodity bazaar promises a provincial Swedish city new life. A car parts distributor is snapping up ailing companies in the U.S. Rust Belt, a TV factory hums in South Africa and a high-tech firm is landing contracts to revamp the Persian Gulf’s telecommunication networks.

Chen and his fiancee, Joy Chen — both took American first names — moved from Shanghai to Atlanta to set up shop for General Protecht Group Inc., a company controlled by his father.

The Chinese corporate presence is still small overseas, but it’s growing fast:

• Chinese companies invested more than $30 billion in foreign firms from 1996 to 2005, nearly one-third in 2004-05 alone, according to an analysis by Usha Haley, a professor of international business at the University of New Haven. Computer maker Lenovo Group helped launch the frenzy in December 2004 by announcing it would acquire IBM Corp.’s personal computer unit for $1.75 billion.
• In the United States and Canada, Chinese firms now have about 3,500 investment projects, compared to 1,500 five years ago, according to an estimate by Maryville University professor Ping Deng. Large state-owned companies jumped ahead; medium and small private firms are catching up. Total investment in the U.S. is between $4 billion and $7 billion, Ping estimates. In Europe, Chinese acquisitions last year alone totaled $563.3 million, according to research company Dealogic.
• Last year, 29 Chinese firms debuted on U.S. stock exchanges, just two shy of the total for the previous three years combined, according to the Bank of New York Mellon Corp.
• The number of U.S. visas issued to Chinese executives and managers who transfer to U.S. posts within their companies nearly doubled to 2,043 between fiscal years 2004 and 2007. The current fiscal year is on pace to top that, U.S. State Department statistics show.

Chinese businesses are not just establishing offices and factories overseas. They also are developing and selling products under their own brands, rather than simply supplying Western firms in search of cheap manufacturing.

Unlike the Japanese, whose 1980s arrival in the U.S. was at first greeted as a threat, Chinese businesses are being courted by states including Michigan, California, Illinois and Georgia.

Few Chinese companies have been in the U.S. longer than the American subsidiary of the auto parts giant Wanxiang Group, which incorporated in 1993. The founder of the home company is one of China’s richest men. His son-in-law, Pin Ni, led the Chicago-area subsidiary from cheap parts supplier up the value chain by buying or working with companies that were distressed — owing to competition from China.

Wanxiang America Inc. has been welcomed for saving manufacturing jobs. Illinois has proclaimed a Wanxiang Day and Michigan offered the company subsidies.

“Even today you want to say, is there enough Chinese companies in the United States?” Pin asks. “I would say no.”

I am not sure if I now ready to sing the praises of Wanxiang America in the way that this article does, but this does provide an interesting thought. We have seen China flex its economic muscle in allowing some of its banks to go public and making heavy economic investment in Africa. It’s only a matter of time when we see more Chinese companies going head-to-head with American and European MNC’s. (maybe not competing head-to-head yet, but in the future it seems possible)

And of course, with such movement into America, guess who benefits? It’s not just the American workers who get jobs. It’s also the lawyers who will be helping such Chinese enterprises setup shop here. If you thought the choice between WFOE and JV was bad enough, you haven’t seen anything yet. In California alone, there are numerous corporate entities to choose from for such businesses:

• Corporation - S-corp, C-corp, or close corporation
• Limited Liability Company (LLC)
• Sole Proprietorship
• Partnership (general)
• Limited Partnership
• Limited Liability Partnership (LLP) - not applicable to the average Chinese business, but I have heard that some Chinese law firms are beginning to move into town.
• Professional Corporation (PC) - same comment

If this wasn’t bad enough, in other parts of the U.S. you have the business trust, the limited liability limited partnership (LLLP), the series LLC, etc. Sounds like Alphabet Soup to me.

And this doesn’t mention combinations of these various forms. Prime example: foreign investment engaging in a joint venture with an out-of-state entity could form a closely held California corporation for asset holding and then form an LP or LLC with the out-of-state entity. This allows pass-through taxation to the California corporation and the out-of-state entity, where you want taxation, and not at the joint venture level.

What’s a company to do? You can buy a publication like CEB’s Selecting and Forming Business Entities (disclosure: 2 partners at my firm wrote the chapter on Limited Partnerships and I “contributed” to this year’s major revision due to Re-RULPA, Corporate Code 15900-15912.07). And then pull your hair out trying to determine which iteration of Alphabet Soup is actually better. Or you can find a good lawyer. Or the more likely scenario for Chinese clients, both. (and then drive your lawyer crazy too… I can’t tell you how often this happens!)

In the future, I will try to cover some of the pros and cons as to particular entity structures versus others. But in the meantime, choose your poison. There sure are a lot of them to pick from.