Careful handling vital for China

03 March 2012 By Lawyers Weekly

Unique challenges to business exist in China and a rough and ready approach may have dangerous repercussions. Sensitive adherence to principled and risk-conscious policies, writes Christopher…

Unique challenges to business exist in China and a rough and ready approach may have dangerous repercussions. Sensitive adherence to principled and risk-conscious policies, writes Christopher Betts, will help to produce safe and successful ventures.

Foreign investors have been concerned by charges recently levied against Rio Tinto employees in China. The situation is not assisted by some commentators whose message is that an inscrutable China cannot be understood by foreign businesspeople. But with a proper appreciation of the risks involved and a thoughtful approach to legal and risk management, operating in China need not be as difficult as it sometimes seems.

Firstly, let's be clear - improper business practices do exist in China as they do in many other countries. However, these irregular practices are more a reflection of the current state of development in China rather than an embedded part of the local culture.


Such practices have proliferated in an environment characterised by low official salaries for government and state-owned enterprise employees, policies highly protective of state-owned enterprises, and private sector entrepreneurs who feel compelled to adopt creative approaches to obtaining licences and approvals. With living costs in large cities rising dramatically - in some instances to levels comparable to international financial centres such as New York or London - and ever-visible displays of wealth, there is also a temptation to pursue a quick buck. Indeed, there is a widespread perception that only those prepared to cut corners are able to succeed, and are very rarely penalised.

Enforcement remains a key issue. At the moment, enforcement of laws in China remains very localised, inconsistent and, for some laws, virtually non-existent. With no effective separation of powers between the government, law enforcement bodies and the judiciary, political impetus often drives enforcement. In the corporate context, companies often have a similarly haphazard approach to instituting proper systems of rules and guidelines to prevent improper behaviour. This has the effect of emboldening those engaged in improper practices with the thought that their behaviour represents a low risk.

Importantly, the tide is turning. In the next week the Central Committee of the Communist Party is widely expected to pass a new regulation requiring officials to publicly disclose the assets of their families - a move expected to improve the transparency of the financial affairs of officials. Most seasoned businesspeople in China have now also had sufficient interactions with foreign companies and institutions - including through having their companies listed on foreign stock exchanges, issuing debt or equity to foreign investors, or forming joint ventures. Many are aware of the fact that foreign companies and their employees are bound by laws on probity, such as the Foreign Corrupt Practices Act or Australia's Criminal Code Amendment (Bribery of Foreign Public Officials) Act.

That said, foreign companies operating in China need to (a) identify the legal pressure points involved with their business (b) quantify, to the extent possible, their likelihood and impact and (c) consider compliance mechanisms to further minimise or eliminate their likelihood, or, should they eventuate, mitigate their impact. A foreign company may not be able to prevent an investigation taking place, but it is able to ensure that its affairs are in order if one occurs.

The most important task is instilling the appropriate mindset in employees, educating them about the principles, rules and policies in place to manage risks, and - essentially - ensuring that communications from the top down consistently reinforce the importance of upholding those principles, rules and policies. If senior management isn't serious about instilling a compliance mindset, there is little point expecting lower-level employees to behave any differently. Living and breathing the right principles, and creating an environment that both rewards the right behaviours and provides an assessable and clear career development path for employees is fundamental.

Lawyers Weekly Discover

During the first phase of the employee relationship - the hiring process - it is important to probe candidates as much as possible: follow up on references, ask for original documents, verify academic qualifications (falsification of degrees is widespread, but each degree has a number that can be checked in a central online database), and, for very senior hires, consider hiring external investigative firms to conduct more extensive background assessments. Any issue with a candidate that hints at an issue with integrity should be a warning sign. On a side note, it is worth highlighting that since the adoption of the new labour contract law on January 1, 2008, employees have been successful in more than 90 per cent of disputes decided by Chinese labour tribunals, often irrespective of the merits of the case - serving only to reinforce the importance of instituting robust hiring practices.

Wherever someone is able to exercise a decision-making discretion to the financial benefit of another party there is scope for that person to seek personal gain, or, in the reverse situation, to be asked to make an improper payment in order to secure business. Instilling the right mindset should help avoid this, but additional checks and balances need to be considered on each side of the equation.

When it comes to payments, these might take the form of more stringent limits on banking authorities, detailed reporting lines for payment approvals, joint or multiple approvals for payments above certain thresholds, and internal or external spot checks or audits of particular transactions. Potential vendors or suppliers should be asked to produce certified copies of business licences and approvals to confirm that the business they are conducting falls within their authorised scope of business (and, where possible, these documents should be verified with the authorities); references should be asked for and followed up. To avoid the possibility of cosy relationships arising between employees and suppliers, exclusive supplier relationships should be avoided, prices should be regularly benchmarked against available comparisons, responsibility for dealing with suppliers should be rotated (or multiple employees should be involved), tender processes should be conducted for large purchases of services or products, and contracts should include the right to audit relevant financial and other records of suppliers.

Scrutiny is especially important for vendors of information, statistics or market research services, which fall within a restricted category of services governed by strict licensing regimes (the last thing the government wants is someone publishing a survey of citizens' views on the government's performance; or statistics showing that all may not be as rosy as the government's own statistics indicate). If the vendor isn't licensed to do what they are doing, don't use them. If information is sourced from government agencies, officials or state-owned enterprises but they can't clearly articulate how it is collected, how they are authorised to pass it to a foreign-invested company, or how they remunerate their sources, don't use them.

It is important to also remain vigilant about areas of sensitivity to the government. Maintaining regular contact with Chinese legal counsel helps because some maintain regular government contact and are invited by the government to participate in the drafting process for new laws, allowing them to give valuable input into the government's thinking. Legal counsel also represents a transparent and legitimate means through which relationships with relevant authorities can be developed. Carl Hinze, an Australian lawyer working in the Shanghai office of international law firm Eversheds, notes: "The reality is that in order to succeed in China foreign companies and /or their advisors need to have transparent and reliable relationships with the relevant governmental authorities to ensure that they are supported by the authorities in the pursuit of their legitimate business plans in China."

Having a contingency in place in the event of a knock on the door from the authorities is also worthwhile: educate front-desk staff about what to do in the event that the authorities turn up at the door; observe best practice when it comes to document retention and management and storage of sensitive information (some companies maintain sensitive information on offshore servers); maintain clean desks; have a clear knowledge of where particular records and items are located in the office so that the authorities can be directed immediately to that location.

Ultimately, as with other countries, the success or failure of a business in China is going to depend first and foremost on the quality and appeal of the service or product a company offers. I once received a call from the manager of a vendor to a former Chinese state-owned enterprise client of mine who informed me that a middle-level manager at my former client had approached her and indicated that her company would be given further business only if they bought him a car - fortunately, they declined to do so, but continued to receive business from the client because their business proposition was simply the most compelling.

Christopher Betts is the associate general counsel at McKinsey & Company

Careful handling vital for China
Intro image
lawyersweekly logo