Southern Perspective Shenzhen

Interesting commentary by Stan Abrams over at China Hearsay about Huang Songyou, the former Vice President of the Supreme People’s Court.

Stan’s question is does admission of corruption at this high of a position give you more or less confidence in the Chinese Supreme Court?

All of us that eat, sleep and breath China know how important appearance or the mysterious “face” culture is here.

To me, seeing someone at that high of a governmental position removed from his post for corruption is a step in the right direction, as it is always difficult for people to admit that there are problems.

As David Dayton at Silk Road International  points out in his latest blog post, the western mindset is different from the Chinese.

3. Identify a common enemy. Once the cat is out of the bag and there is admission that there really is a problem (often a huge first step) then you have to find out both where the problem came from and then how to fix it.  My experience is that while I’m interested in getting problems fixed (solutions to meet deadlines) the factory is more often concerned with finding someone to blame—usually a sub-supplier.  It’s always the sub-suppliers fault. While it may seem antithetical to what you’ve been taught in business school, sometimes letting the factory place blame on someone is not always a bad thing.  Regardless of what (or when) the outcome is, someone will pay for the mistake and so getting the blame game over with as soon as possible is often the best way to move on to what the resolution options are.  While I never like seeing one person get nailed to the wall (as it’s never comfortable and almost never only one person’s fault) if you can’t avoid it, minimize it by moving on to the solution as quickly as possible.

Blame must be placed on a few shoulders as possible and once blame has been placed on a scape goat, it is time to move forward with the business at hand.

While I find it encouraging that the mistake was admitted (although not much else as it looks like Mr. Huang Songyou will walk away with just a slap on the wrist), is this an indication that the Chinese legal system is tightening on corruption or that it is more wide spread that was first believed?

In the famous words of Davey Crockett “Remember Rio Tinto!”, or something like that.

The majority of government regulations that divide the financial services industries in China are still in place, but as is often the case, there are ways of getting around these regulations.

Companies may apply for China Banking Regulatory Commission (CBRC) approval to engage in insurance or securities activities.

It then becomes the regulatory commission’s duty to oversee and inform the companies as to what ways their subsidiaries are allowed to cooperate, and in what ways they must remain separate.

Chinese banks are pushing the commission for a more universal banking regulatory framework, which is enticing because of all of the business growth opportunities it offers for the developing Chinese Financial market.

With international banks pursuing entry to the Chinese financial services market the CBRC will have the increasingly difficult task of developing regulation.

The CBRC must ensure that the Chinese financial market matures and develops while nurturing a young sector of China’s national economy to compete with mature international competition.

The fastest way to develop the financial market is for local Chinese banks to look for international talent and there isn’t much to slow local banks from hiring western talent, after the massive job losses western banks and financial service sectors.

Many have blamed the shortcomings of Western banks on overzealous greed, and lack of regulation in keeping the banking sector apart from the capital markets.

This accusation very well may be true, and the Chinese financial system should benefit greatly from looking at and analyzing, the cause of the Western banking system’s collapse.

The heavy regulations that led to the slow development of these separated Chinese banking, insurance and securities markets has greatly insulated them from the problems that currently face Western financial firms.

While I believe that this was due more to lucky timing, as opposed to prudent planning, the Chinese financial system appears to be poised to take a leadership role this century.

While the Chinese financial firms were straining to be released from the CBRC heavy regulation, as the early 2009 Citigroup restructuring shows us, this so-called ”universal banking” might not be the perfect solution that it was once touted to be.

There must be some balance between the financial service firms having the freedom to pursue profit and growth, and government efforts to monitor and regulate their activities.

As the western financial meltdown has revealed, massive profits are not necessarily an indication of the health of a business, especially a business that is so entwined with so many nations’ economic stability.

While Chinese banks dream of making the profits their Western counterparts did for some many years, the Chinese market will be much less responsive to the sophisticated financial products offered in the West.

 The Chinese are much less willing to take financial risks, especially now that the weaknesses of the Western banking system have been exposed.

Two months ago I talked a little about a new online database that can help you investigate companies within China that have a record in the court system. You can find that here. What this record details is the company’s delinquency on a judgment from a court. For example, company A was ordered by the court to pay company B but has not paid company B.

A good friend, Seth Buckley, wrote a piece about the Judgment debtor system and is featured in China Law and Practice . It is titled Nowhere to hide and explains how the online Judgment debtor system can be used for your due diligence in China.

Seth writes:

The primary purpose of the new database system is to increase compliance with executable judgments issued by Chinese courts, a task that has been notoriously difficult in China. As well as providing critical information for due diligence evaluations, the database uses potential reputational loss to pressure the debtor into satisfying its obligations and the courts into facilitating debt collection…

…Companies can now incorporate this information into their due diligence analysis and perform a more meticulous evaluation of an entity’s financial stability. This can be critical for determining a potential business partner’s dependability in commercial contracts, as well as for evaluating target companies for mergers and acquisitions.

The database could thus potentially affect a debtor’s reputation as a desirable future business partner. This will give debtors greater incentive to settle their debts in order to protect future interests.

Seth really brings the point home, make this step apart of your due diligence. If you’re going to do a project here in China and using a considerable amount of your funds, confirm the reputation of the company. The last place you want to be is at the other end of the proverbial stick with a company that does not make good on its responsibilities.

If you would like to read Seth’s complete article, you may sign up to China Law and Practice for a free trial. To have a look at the database (all in Chinese) look here . If you guys have any questions on the database, send me a comment.

Banks all over China have been salivating over the prospect of being able to offer a wider range of financial services. 

While the last year of financial turmoil has cooled the drive to deregulate the strict divisions placed on the services that Chinese banks and financial institutions have been about to offer.

The first steps towards a “financial supermarket” of services came from a small tweak in the restrictions in 2000 and 2001, a significant change occurred in 2002 with the establishment on China Unionpay. 

Both the state council and the PBOC approved this new company even though the business’s operations were outside of traditional banking activities such as taking deposits and making loans. 

This state approved exception to the strictly established separations appeared to signal that the PBOC would begin to consider relaxing the imposed divisions.

While the PBOC gave itself an undefined ability to declare certain business practices permissible for some firms, they also gained the ability to ease the restrictions for some companies while maintaining the strict divisions for the vast majority of financial firms. 

The 2004 Memorandum of Understanding on Division of Responsibilities and Cooperation was designed to clarify the exact responsibilities of the China Banking Regulatory Commission, the China Securities Regulatory Commission and the China Insurance Regulatory Commission. 

In 2005 the PBOC allowed the Bank of Communications to begin to engage in fund management activities. 

The Chinese officials and government regulators felt that they had patiently developed a system that could gradually be reintegrated from the chaos that engulfed the unregulated markets 10 years before. 

As Chinese officials admired the international financial firms that, at one point in time, appeared to be almost bullet proof, they strove to slowly break down the walls that separated banking, fund managing, insurance, trusts and finance. 

As Liu Mingkang stated as the head of the CBRC in 2006;  

“Banks in Western, developed countries are increasing their capabilities and functions by the day. Jointly operating banking, securities and insurance businesses is a huge development trend.”

 And in the China Daily in October 2006; 

“The time is ripe not to make it clear that the barriers [between different financial businesses] will be torn down gradually to give our financial institutions an opportunity to become more competitive and thus make the whole financial industry more efficient.”

You remember when your high school teacher gave this advice to help form a thesis for your paper at the end of the year? It does not make for mind breaking commentary on subjects but it does help you form a complete idea and get your point across.

I think this  method is great when working with suppliers over here in China. One thing you want to avoid in China is ambiguity. As I said in my first post, China is not a place you want to “figure things out”. If you are relying on the company to give you solutions, you will not get what you want.  To get to my theory above, let’s start with the first part of our new Mantra:

Tell them what you’re going to say

Always know more. Be prepared with your material before you start and know your specifications. Now that you have a clear path, email your supplier with your intent. You are not giving them specifications now, you are weeding out suppliers.

Say it

At this point, you should have a collection of possible suppliers that you are ready to work with and have responded to your request. You and your possible suppliers should be on the same page.  Now is the time to get into the details of the specifications.

Then say just what you said

This part is usually in the beginning to middle of your interaction. This is a kind of a reminder of your requirements. I have received samples of different materials than the specification I gave them. Some of the explanations I get are:

This is only the sample , so we thought this was easier

Or

This material was easier to get

Or

This was cheaper to do

Or

We will do right next time in production.

Clarify your specifications and sometimes there is a need for a change. If a change is necessary,  ……… tell them what you’re going to say, say it, then say just what you said. REPEAT

There are always variables to these situations. But the biggest piece of advice I can give is, be clear in your goals, be consistent and be knowledgeable. The next step is production and that opens up a whole new can of worms.

Any other methods that work well for you?

I remember when I first came to China and I was amazed by the Luohu train station in Shenzhen. It is was (and still is ) a Mecca for copy brand products. Anything that has brand visibility, is copied and sold. Those of you that had been here know this to be true. It is everywhere in China and not just Luohu station. It seems it would be an impossible battle to fight such a thing.

Just last week, Louis Vuitton Malletier of “LV” just did that. In a case of trade mark infringement , Louis Vuitton Malletier, won the verdict of 500,000 RBM to be paid as compensation from one particular shop in Shanghai. What is interesting about this is, it hit people at a street level. Compared to what the shop owner and trade company made off these bags, 500,000RMB is not a very good compensation. BUT I think this still sends a message, even though a small one.

Will this case be the end of counterfeiting and trade mark infringement ? Most definitely not. Let’s look at this as a goal that will be done one step at a time.

Last year a friend of mine came to me with a project for an American company that was trying to get a business loan from a major bank here in China.

I asked some banking lawyers in Hong Kong what they thought the client’s chances for obtaining a loan in China were and they all agreed that it would be pretty unlikely.

Basically it is most unlikely that a foreign company without a track record of dealing with Chinese banks will obtain credit lines from Chinese banks.
 
Chinese banks are moving toward becoming standard Western commercial banks – they always look for profitable and safe investment, but this is a very slow movement.

When they do extend credits to what may look like risky borrowers, it is always because either they are pressed by local governments or some key bank managers are otherwise influenced in the decision making.

In practice, local governments may act in favor of major FIEs that matter to local economy, but perhaps not a “pure” foreign company.

So, unless they have a track record of doing a significant amount of business in China or they have funded major investments in infrastructure development or they employ a large number of Chinese workers they don’t have much of a chance.
 
You might be able to get financing if you can persuade a local government to give the banks a nudge, meaning you either employee a huge number of local Chinese in your company or JV or you have enough pull with the local government to get them to go to bat for you.

It got me to thinking about Chinese banking, the big 4 Chinese banks have some of the largest holdings of bank in the world, how do they make loans? Why would foreign businesses have such a difficult time getting funding? The answer comes down to a practice called “Window Guidance”.

Window Guidance is a favorite tool of the PBOC, this is an idea that is borrowed from the Japanese banking system.

The PBOC uses window guidance to “guide” the lending polices of the big 4 banks.

This is accomplished through a combination of moral pressure, to support the national government’s policy wishes, and the hidden threat of “complications” with money supplier from the central bank, as the PBOC controls this lending.

By allowing the market to make an “educated guess” as to what the lending policies of China’s biggest banks will be, the PBOC allows the largest banks to appear to act independently but in actuality, they are somewhere in between the planned economy and a completely market based economy.

While the central bank does not technically direct the lending of the big four banks, they do apply pressure in the banks to follow the governments policies.

The big four banks generally adhere to these policies because the PBOC provides the banks with loans.

These direct loans from the PBOC to the commercial banks are a very useful tool in maintaining the stability of the financial system.

Providing banks with a gift wrapped mini bail out allows them to work through difficult times without being completely accountable to shifts in the market.

The opposing argument, often heard regarding U.S. financial market bailouts, is that these types of low interest loans will encourage the banks to engage in risky behavior with less restraint, because they expect to be taken care of.

These financial institutions will then become too big or important to fail, forcing a government to take more responsibility in overseeing the operations.

Having the government’s monetary policy so closely intertwined with what are regarded as independent private banks in the west is a troubling thought for those that tout the free market over all.

But judging by the manner in which recklessness and greed played such an integral part in the deep troubles of the American and European banking systems, maybe having a government oversight committee is an intelligent move.

Giving the committee some real power to act and intervene when it sees potential abuse seems to be an intelligent solution to the West’s current banking system difficulties.

Window guidance is a very important tool for the PBOC, it will play a major part in the Chinese government’s 2009 economic stimulus plan.

The central bank has made it very clear that they expect their contributions to the economic stimulus package to be matched, on a 1 to 1 ratio, by the big four central banks.

This is also a policy that the West should strongly consider using, there needs to be some balance between allowing a free market to guide itself and making the big national banks into puppets that are incapable of making intelligent decisions of their own free will.

The type of cooperation that China promotes between the responsible government agency and the banking sector is a model that the west should attempt to emulate with the shares they have acquired “bailing out” western banking entities.

In the case below we can see a direct application of good faith, bad faith principles and how the court uses them. This case includes trademark infringement and a famous brand of dumplings, Gou Bu Li. （狗不理）

I will run over the basic facts of the case. There are two companies that use the same characters, Goubuli, for their brand name of dumplings. The plaintiff, Tianjin Goubuli, registered the Goubuli trade-mark in 1994. Tianjin Goubuli is also considered a “well known trade-mark in China”. To find out more about “well known trade-mark in China”, Chinalawblog has a great post on this. The defendant, Tianfengyuan of Jinnan, is also a producer of the famous Goubuli dumpling and uses that name in its restaurant.

Tianjin Goubuli is suing Tianfengyuan for trademark infringement on the use of the name “Goubuli”. Tianjin Goubuli believes Tianfengyuan uses the name intentionally to confuse costumers and gain additional revenue via “hitchhiking” from the brand name recognition.

Tianjin Goubuli tells the court, Tianfengyuan is using the name in bad faith. As it turns out, Tianfengyuan has been making Goubuli dumplings since the 1940’s and has continued since to make Goubuli dumplings famously in their city of Jinnan. “Goubuli Steamed Dumplings Stuffed with Pork and Soup”, was one of the many logos they used in/on the restaurant. Catchy right? It was famous in Jinnan in its own right.

Since history plays a part in all this, the court finds that Tianfengyuan was not acting in bad faith. It was using the name way before Tianjin Goubuli was created and was not using the name to confuse the customers and gain extra profit. In fact, they were using the name in good faith. They used the name, as they had used in the past, to represent their company’s famous snack. Even after Tianjin Goubuli became famous after 1994, Tianfengyuan still had not tried to use the name for bad faith purposes.

There were some banners and menus that only had the characters, Goubuli. They were not considered to be used in bad faith and asked Tianfengyuan to remove those characters, which are a registered trade-mark of Tianjin Goubuli. All other compensations were rejected.

What is important about good faith and bad faith distinction in this case is the difference between being sued for compensation or not. If the court found Tianfengyuan using the name for misleading people, compensation would be necessary. Intent and being able to prove it is important.

A quick note… good faith and bad faith, is not only about trade-marks. It is a general principle that can be used in all applications of law and business situations. A big problem about this subject above is proving it. You need to have clear map of showing HOW something was not done in good faith. WHY was in done in bad faith? Simply claiming it will not get you the results you’re seeking.

Last week I talked about good faith. This principal is not unknown in other law systems. I would like to give you idea what good faith or bad faith means. The way I see good faith is — honest intent and non malicious conduct and bad faith would be the opposite. When you make an agreement with someone, your honest intent is to fulfill that agreement. The reason we enter into agreements, promises or contracts are to guarantee fulfillment. If this was not the basic fact of a contract, it would be worthless as the paper it is written on.  This seems like it has a bit of a DUH! factor going on but these principals are used in many laws. Let me give you a small look:

Contract law:

Article 6 The parties shall observe the principle of good faith in the exercise

of their rights and performance of their duties.

Article 42 A party shall be liable for compensation if he, in the course of concluding the contract, causes damage to the other party in one of the following situations:

1. he negotiates in bad faith under the pretext of concluding a contract;

2. he intentionally conceals a material fact relevant to the conclusion

of the contract or gives false information;

3. he engages in other acts that violate the principle of good faith.

Looking above at article 6, what does that even mean? What about article 42, “1. he negotiates in bad faith under the pretext of concluding a contract”? For the first example, it means acting in honesty or correct conduct and for the second, malicious behavior. For example, intentional trying to have a contract fail or breach.

Good faith and bad faith are a bit of catch-alls. They are general principals law might not be directly addressing or law that has not been developed yet. This is especially important for China, since the law system is in constant flux. In the country side, for example, updated national laws are not know yet or simply not followed.  This one catch-all of good faith and bad faith is a still constant and has been from the beginning.

This week I will give more examples of how good faith and bad faith are used.

This is another post that was first posted on the Silk Road International Blog

Third party contracts cover a side variety of topics that concern people doing business in China. These types of contracts involve;

• Contracts of carriage, a contract where you (A) have a shipping company (B) deliver goods to a client (C).

• Some types of insurance contracts where you (A) purchase insurance from a company (B) payable to another company (C).

• Third party inspection contracts where you (A) hire a company to inspect goods (B) from a supplier (C).

What are the obligations of a third party? These contracts are specifically different from contracts in which a task is delegated (subcontracting). These types of contracts are those in which a third party is added to a contract to perform a responsibility or a part of a contract. Under Chinese Law, you are still responsible to uphold your obligation.

So, who is to blame when things go wrong? What happens when a shipping company refuses to deliver goods to your client? When an insurance company refuses to pay a claim? When a line of products that were inspected results in a massive recall? In situations where the third party refuses an obligation or performs their obligation in an unsatisfactory manner, what course of action can you take?

Unlike the Common Law system in Hong Kong, in which consideration, compensation, must be made before a contractual promise becomes legally binding. In the Chinese legal system, even an orally made promise can be legally binding, as long as the three conditions for making a legally enforceable contract are met.

Those three conditions are,

1. The person must have capacity (mentally sound and of age)

2. The person must have intention (no duress or forced conditions)

3. The promise must be legal (no refunds for your illegal drug mules) As long as these conditions are met, any promise that you make can be considered legally binding.

So what are the implications for third party contracts? If the intention of the two parties is to place a legal, contractual obligation on a third party and this intention is accepted by all three parties, then the wronged party has a legal claim against the third party. This means that you have a claim against your insurance company for not paying, against the inspection company for failing to inspect properly and against the shipping company for failing to deliver the goods as agreed to.

The next time you are finalizing a deal make sure that your intentions are clearly expressed. What are each of the parties’ individually responsible for? What are their obligations? What are the remedies in case anyone should fail to perform in a satisfactory manner? It is better for you to decide ahead of time about the solution to a problem rather than rely on a judge here to take a guess.