As China emerges from the economic downturn, the rules of the game have changed. Law firms are adapting to the new environment, and in-house counsel are under pressure to do more work in-house By Robin Weir
“I’m not sure whether the financial crisis is through, or whether it hasn’t hit China yet,” says Cheryl Luan, a partner at Guantao Law Firm in Beijing. Luan’s uncertainty reflects a small but persistent worry at the back of many lawyers’ minds. To underpin economic growth in the face of the global financial crisis, the government pumped a startling amount of cash into China’s economy. (The figure announced in November 2008 was RMB4,000 billion, or US$586 billion.) According to the European Union Chamber of Commerce in China, the total amount lent by Chinese banks in the first seven months of 2009 will be almost as much as the totals for 2007 and 2008 combined. But the jury is still out on whether this stimulus money has had the desired effect, or whether it will merely delay an inevitable economic shock. “Is it really over,” asks Luan, “or has the centra government invested so much money that after the whole world is through with the crisis, we will suddenly start to feel it?”
Law firms are certainly feeling it, as their clients seek to save money by taking more work in-house. Gregory Morrow, vice-president and chief legal officer at Contessa Premium Foods in California, notes that over the next year his legal department will be “focused on doing more with less by taking on additional responsibility for legal tasks such as intellectual property, litigation and regulatory compliance that have previously been assigned to outside lawyers”.
Morrow is by no means a lone voice. The vice-president and general counsel of a high-technology manufacturing company in the US believes that “the high cost of outside law firms will encourage more ‘in-sourcing and the development of in-house counsel to handle work internally”.
The voices from North America find echoes in Europe and China. “More and more jobs have to be done by in-house counsel which in the past were given to outside counsel,” says Birgit Medeke of Zwilling J Henkels, a manufacturer of high-quality cutlery in Solingen, Germany. And Tina Min, senior China attorney at Wrigleys Confectionery in Guangzhou, sees the need for “a growing and more expertise-diversified in-house counsel team”. Min is one of a number of survey respondents who see the role of in-house counsel growing in both size and importance. Frank Wang of Anheuser Busch Inbev believes that “more and more, the in-house lawyer will be involved in decision-making”. Sophia Fan of Owens Corning in Shanghai states that “in-house counsel will be required to know more about detailed business operations and be involved in the design and adjustment of the business model”.
Where’s the money?
Squeezed by clients with tight budget constraints, it seems that lawyers cannot look to the government’s stimulus money for salvation. “The financial market is mainly being driven by the local banks, which are chasing after the big deals created by the government,” says David Dali Liu, a partner at Jun He Law Offices in Shanghai. Unfortunately, in Liu’s view, such deals do not offer much scope for sophisticated legal work. The banks appear to be relying on the government’s reputation as their primary means of risk control, with the result that large transactions can take place with straightforward structures, and relatively little documentation. “That is not our market,” says Liu. “Lawyers do not add much value to the transaction.”
Likewise, adds Liu, lawyers may see little work from an increasing move by local governments to issue bonds and invest in projects. “The legal market is different from the market,” he comments. “I don’t see that that will be part of the legal market.”
But while lawyers may be disappointed, the prospect of local government money is causing quite some excitement in private equity circles. And that could be because the money might just be free. “The private equity players are trying to create new ways of doing things, and they are speaking to local governments about the possibility of entering into partnerships,” says Carl Hinze, an associate at UK firm Eversheds in Shanghai. While China currently lacks a theoretical legal basis for a foreign entity to be the general partner of a private equity partnership, that is precisely what private equity investors are now proposing, says Hinze, with the local government involved as, perhaps, a limited partner. Local governments may, Hinze adds, have access to funds granted to them by the central government for investment in local projects as part of the stimulus package. If a private equity investor plays its cards right, this money may be available as a grant to a private equity fund, with no strings attached.
With or without free government money, many lawyers clearly see a renaissance in private equity activity. According to Thomas Britt, a partner at Debevoise & Plimpton in Hong Kong, the growing number of RMB-denominated private equity funds that are being established in China is one of the most important legal developments of the past six months, and will continue to feature strongly in the coming year. “The continuation of the development of RMB-denominated private equity funds will be [one of] the most significant developments affecting our business and our clients over the course of the next 12 months,” predicts Britt.
Capital markets reviving
RMB funds aside, the story of the capital markets in autumn 2009 was one of renewed activity after a long stupor, with some major new developments on the horizon. “Perennially interesting are the policy manoeuvres of the China Securities Regulatory Commission [CSRC], both as far as Hong Kong is concerned and also for the domestic market,” says Michael Fosh, a partner at Reed Smith in Beijing.
The CSRC’s “manoeuvres” have led the market from famine to feast. In September 2008 the CSRC imposed a nine-month moratorium on A-share IPOs, after the Shanghai stock market lost over 60% of its value from its peak in October 2007. With the lifting of the moratorium this summer came fears of a new bubble, as funds flowed back into the market. Shares in China State Construction Engineering – listed in late July this year – rose by as much as 90%, before closing their first day 56% above their offer price.
A-share listings continue apace, but it is the establishment of two new markets – ChiNext, the new secondary board in Shenzhen, and a mooted international board in Shanghai – that seems to offer the greatest potential in the eyes of many lawyers.
“There is a report that something like 159 companies are being vetted at the moment for secondary board listing in Shenzhen, so there is clearly a lot of activity there,” says Fosh. And the much-anticipated international board holds out the possibility of international companies acquiring a new trading platform via a listing in Shanghai. Fosh believes that while the creation of such a board has been under discussion for at least a couple of years, any delay may have been due to policy, rather than legal, considerations. “The legal impediments would not be great,” he says, although there would be “some work to do” reconciling the PRC Company Law and PRC Securities Law with the legal regimes of listing candidates’ home jurisdictions (such as the Hong Kong Companies Ordinance).
FDI slows but MOFCOM responds
While private equity may be heading in new directions and the capital markets seem full of promise, the picture for foreign direct investment (FDI) is looking decidedly mixed.
In its European Business in China Position Paper 2009/2010, the European Union Chamber of Commerce in China notes that “European businesses are still impeded by issues concerning market access, legal and political transparency and the protection of intellectual property rights. The spectre of protectionism has also appeared, and European companies are increasingly concerned by the tendency for local companies to be favoured over foreign-invested ones.” The same report goes on to complain of “a gradual slow down – and in some cases a partial reversal – in the opening up process”.
Yuan Changchun, a partner at Broad & Bright in Beijing, notes that FDI has been slow and “will take time to pick up”. But the slowdown has clearly been noted by Beijing, and a response is evident. Ulrike Glück, a partner at German law firm CMS Hasche Sigle in Shanghai, points to three circulars issued by the Ministry of Commerce (MOFCOM) in March and May 2009, which delegate examination and approval authority for projects down to lower-level authorities. Notably, one of the circulars delegates approval authority for the establishment of holding companies up to a registered capital of US$100 million to the provincial level. “By delegating down the approval authority, these circulars are an attempt to revive foreign investment or to make it a little bit easier,” says Glück.
Restructuring and renegotiation
With less work to do establishing new foreign investment enterprises (FIEs) in China, some law firms have found work restructuring those that are already in the country. “We are seeing a whole lot more restructuring proposals,” says Peter Corne, managing director of Eversheds in Shanghai. “They all involve consolidating existing networks of FIEs, either through asset acquisition or the merger of FIEs within a group.” Matthias Müller, a partner at Salans in Beijing, observes that clients with manufacturing operations in China have begun to switch their attention away from production towards sales and distribution networks. “Their manufacturing projects may be on hold, but they are going very much into distribution structures and selling things into China,” he notes.
For King & Wood, restructuring work has also mushroomed. Partner Susan Ning in Beijing points to the firm’s work in the state sector, and the busy lives of a bankruptcy team that was formed long before the promulgation of the PRC Bankruptcy Law in mid-2007. “We have helped a lot of State-owned enterprises reorganize their debts,” she says. “Our bankruptcy practice started in Shenzhen where they promulgated the first bankruptcy regulation for FIEs 12 or 13 years ago. So when the bankruptcy law came into effect, we already had a mature team and a solid practice.”
Alongside restructurings and bankruptcies has come a renewed focus on dispute resolution, for both clients and their lawyers. “In the recent economic crisis, lots of lawyers have turned their attention back to traditional business. Dispute resolution is one such traditional legal activity in China,” says Dong Chungang, a partner at Jingtian & Gongcheng.
As businesses have been restructured, so commercial contracts have been renegotiated. Peter Murray, chief representative of Ince & Co in Shanghai, has been involved in much contractual renegotiation, particularly of shipping contracts. Murray offers a positive interpretation of how PRC law has performed in the global financial crisis. “If there is one feature of the legal landscape in China during the past six months, it is that the rule of commercial law has held together very well in the sectors Ince & Co serves, namely shipping, trade and related finance and insurance,” he says. “Renegotiations generally took place within a proper framework and in the knowledge that the force of law was available.”
Murray points to two things in particular as worthy of note. First, he cites the so-called “Rule B attachment procedure” of the Supplemental Rules for Admiralty and Maritime Claims of the US Federal Rules of Civil Procedure, as having been particularly effective in shipping-related cases. Most shipping-related transactions are carried out in US dollars, and therefore involve funds passing through a clearing bank in New York. Under Rule B, such funds may be frozen by a New York judge as potential security for a marine claim, even if that claim is being adjudicated somewhere else in the world. This, says Murray, has encouraged the effective settlement of claims. “If Chinese parties know they are going to get their funds frozen in New York, then they have got to play by the rules,” he says. “By the same token, Chinese parties are using it as well. It’s a two-way street.”
Murray also notes a change to Chinese law that was made as a direct result of the global financial crisis. A Supreme Court interpretation concerning the application of the PRC Contract Law, issued in May, allows courts to terminate or amend the terms of a commercial contract where there has been a dramatic change in economic circumstances. And clearly, a dramatic change has occurred. He recalls contracts of affreightment that were concluded, pre-crisis, at prices that were “up in the stratosphere”. But those prices then crashed from a daily rate of US$250,000 (RMB1.7 million) to a mere US$5,000 (RMB34,000). Not surprisingly, this occasioned attempts at renegotiation and, ultimately, the Supreme Court interpretation. “The change is in keeping with China being a civil law country,” he says, “but it was the speed of the change which was surprising.”
Just as the world’s economic crisis has had an impact on China’s shipping and trade, it has also coincided with a marked increase in the amount – and visibility – of Chinese investment overseas. It is to the great white hope of Chinese investment abroad that hard-pressed foreign law firms have turned as other work has dried up.
But it may be some time before these firms can enjoy the fruits of their labour. “For law firms, this is a slow business,” says Müller of Salans. “It takes time to get to know the people in a Chinese company. You have to put in a lot of energy before something really happens.”
Chinese companies themselves may be having similar thoughts about the idea of investing abroad. In 2005 intervention by the Committee on Foreign Investment in the US (CFIUS), a body authorized to review foreign bids for US companies in order to determine the effect of such transactions on US national security, led to the collapse of a bid for US oil company Unocal by China National Offshore Oil Corporation.
In March 2008 a plan by networking equipment company Huawei Technologies to acquire a 16.5% stake in US rival 3Com also collapsed in the face of CFIUS opposition. And in June 2009, Chinalco’s bid for up to 18% of Anglo-Australian mining company Rio Tinto failed in the face of strident opposition from Rio’s shareholders. According to Australian law firm Mallesons Stephen Jaques, which acted for Chinalco, the proposals included investment by the Chinese group in various joint ventures worth US$12.3 billion, and the issue of subordinated convertible bonds in two tranches for a total consideration of US$7.2 billion. The deal would have been one of the largest outbound investments by a Chinese company. But in September the Foreign Investment Review Board, Australia’s equivalent of CFIUS, announced that Canberra had a clear preference for foreign investments in its big companies to be capped at 15%. Many observers took this as a clear indication that had the Chinalco deal not hit the rocks commercially, it may, in any case, have been blocked by the Australian authorities.
Away from the headlines, deals with a lower profile have continued. Jin Ding Partners in Nanjing advised East China Exploration in its acquisition of 25% of the shares in Ararfura Resources, a mining and metals company listed on the Australian Stock Exchange. (For more information on investment in Australia, see Australia-China trade & investment). Law firm MMLC acts for one of China’s largest agricultural companies in its investments across the Asia Pacific region. Lehman Lee & Xu, meanwhile, is assisting a Chinese fashion label to establish franchise stores in Los Angeles, Chicago and New York to sell its clothes, shoes and handbags.
While the majority of large Chinese investments overseas have so far come from State sector groups such as Chinalco, private Chinese companies are also becoming active. Sam Li, a senior partner of Jincheng Tongda & Neal, notes an increase in enquiries from both private and State-owned companies interested in acquiring foreign companies with valuable technology. “They want to buy,” says Li. And the many companies in difficulties in the current economic environment across the world may present a golden opportunity to acquisitive Chinese businesses with cash to spare. In general, comments Corne of Eversheds, “it’s easier to buy the company than it is to buy the technology.”
Within China, regulatory approval for domestic companies to invest overseas is becoming easier to obtain. In the past six months, both MOFCOM and the State Administration of Foreign Exchange (SAFE) have issued measures aimed at simplifying the procedures for outbound investment. Australian firm Minter Ellison predicts that more similar measures will follow in the coming year. According to Sam Farrands, a partner at Minter Ellison in Hong Kong, however, matters such as MOFCOM approval formalities are “merely the first step in a series of practical hurdles” for outward investors from China to overcome.
Farrands stresses the need for investors to understand the legal and regulatory regimes of the jurisdictions in which they invest. “They should also be aware of differences in corporate culture and management, as well as the challenges of dealing with employees and other local practices,” he says.
Corruption and compliance
The collapse of the Chinalco-Rio deal was followed by the detention in July of four Rio Tinto employees in China on suspicion of stealing state secrets. The four were formally arrested in August on the less serious charges of obtaining trade secrets and commercial bribery.
The case has focused attention on compliance issues in China in the broadest sense. “Compliance is becoming a very big practice area,” says John Huang, managing partner of MWE China Law Offices in Shanghai. Huang points to increased government compliance work relating to SAFE regulations, tax and labour matters, the local PRC component of commercial bribery, and even compliance with the US Foreign Corrupt Practices Act (for in-depth coverage of this topic, please see The US Foreign Corrupt Practices Act – What companies in China need to know).
Susanne Stollhoff, legal counsel at international IT and software company StepStone Services, believes that compliance matters are of increasing importance to in-house counsel. “Compliance issues get more and more important and require early involvement in business processes,” she comments. Others agree. William Wang, a solicitor at insurance firm Liberty International Underwriters in Hong Kong, notes a new emphasis being placed on the compliance role, which he believes is “a result of the increasingly scrutinizing behaviour of the regulators in regard to the conduct of boards of directors and of senior management”.
The increase in compliance work has also been driven in part by the PRC Anti-Monopoly Law. According to US firm Vinson & Elkins, this is “by far the single most important piece of legislation affecting multinational clients on global M&A and China M&A transactions” to have been promulgated recently.
Much has been written about the law since it came into effect on 1 August 2008. However, the coverage has centred on the merger control provisions, while other areas – monopoly agreements, price-fixing and the abuse of dominance – have been comparatively overlooked. Yet for corporate counsel it is the day-to-day issues of monopoly agreements, price-fixing and the abuse of dominance that are more immediately relevant than merger control – which, clearly, only applies in the rare event of a merger or acquisition. (For an in-depth discussion of this topic, see Counsel voice concern over price-fixing rules.)
And for lawyers, requests from clients for thorough compliance reviews are now becoming increasingly common. “This year I have been approached by top international companies that want us to review their franchise systems and their distribution models to assess whether or not they are in violation of the Chinese monopoly law,” says Zhan Hao, executive partner of Grandall Legal Group in Beijing. According to Zhan, this has been profitable work, with clients prepared to pay lawyers’ fees that pale into insignificance next to the fines that may potentially be levied on offenders. “The billable rate for us is quite good,” he muses.
Can Taiwan compete?
And what of Taiwan in this picture of economic turmoil and legal change? Denise Wong, a partner at offshore specialist firm Walkers, believes that the recent improvement in cross-strait relations has led to “an unprecedented level of interest and activity” by mainland clients wanting to list their businesses in Taiwan or invest there.
Taiwanese leader Ma Ying-jeou is promoting the conclusion of an Economic Co-operation Framework Agreement (ECFA) with the mainland, and CF Tsai, a partner at Taiwan law firm Deep & Far, views the ECFA as potentially the most significant legal development that will take place in Taiwan over the next 12 months. However, Tsai believes that the signing of the ECFA may not be universally welcomed, as Taiwanese worry about the effects of further opening and competition. “A lot of people here worry they could not compete with businesses from mainland China, and would become unemployed,” he says.
For the time being, the most notable feature of cross-strait cooperation is perhaps in the legal sector itself. Since 2008, citizens of Taiwan have been permitted to sit for China’s annual bar examination and practise law in the PRC. Lantern Law Firm in Beijing received widespread media coverage after employing Zhu Xiangyang, the first Taiwanese citizen permitted to practise in the mainland. He passed China’s bar exam in September 2008. “For the legal market to open to Taiwan residents is big news,” says Lantern’s senior partner Arthur Dong.
Reasons for optimism?
What, then, is in store for lawyers and the law in 2010 and beyond?
It is a common observation that international law firms in China have been hit harder by the global recession than local firms. Guo Kejun, a partner at Deheng Law Office, speaks for many when he notes that the economic crisis has had an unequal influence on different types of firm. “Some foreign law firms have been very affected, because they had mostly overseas clients who were badly hit by the crisis. But most of the Chinese firms we have come across, including Deheng ourselves, haven’t really been so affected,” he says.
As to international matters more generally, there are clearly some dark clouds on the horizon. The EU Chamber’s warning of increased protectionism and a “partial reversal” in the process of China’s opening and reform is something for all to heed. And US President Barack Obama’s imposition of “safeguard” tariffs on imports of Chinese tyres raises the possibility of a damaging US-China trade war. According to Wang Lei, a senior partner of Gaopeng & Partners in Beijing and formerly deputy director for trade policy and WTO affairs at the Ministry of Foreign Trade and Economic Co-operation (now MOFCOM), the US president’s approval of the safeguard tariffs amounts to “an action with landmark effect” (see Obama visits, trade issues remain). Writing in the Financial Times on 13 September, Charles Freeman of the Center for Strategic and International Studies in Washington, DC, described the tariff provisions as “widely despised in China as uniquely discriminatory against that country”.
Nonetheless, as China Business Law Journal celebrates the publication of its inaugural issue, there is reason to be cautiously optimistic. “The economic crisis will surely pass,” says Ma Jiang-tao, a senior partner at Dacheng Law Offices in Beijing. China’s stimulus package has, for now, succeeded in underpinning and maintaining the country’s economic growth. Major new laws such as the PRC Anti-Monopoly Law offer the prospect of sensible regulation in areas previously unregulated, and are largely modelled on similar laws overseas. The recent revision of the PRC Patent Law was the law’s third revision, but the first designed to meet China’s own requirements and not in response to international demand (see Practice Notes). And the international stature of Chinese law is beginning to grow.
Zhang Derong, a partner at Zhonglun W&D Law Firm in Beijing, plays down fears expressed by some that in implementing the government’s stimulus package, the banks could be storing up problems with non-performing loans in the future. “We can clearly feel that the banks are being prudent,” says Zhang. “There are many projects that need money, but that the banks will not lend to. Why? Because the project does not meet the criteria. The supervising authorities are constantly emphasizing that although there is a need for stimulus, financial institutions must also manage each project well. They cannot avoid doing what is necessary for fear of running a risk, and waste the investment.”
In the law itself, there are moves towards greater openness and transparency, and reasons to hope that things are, on the whole, moving in the right direction. According to Li of Jincheng Tongda & Neal, pressure is being exerted on judges to publish their judgments. As an example, he points to the Sichuan High People’s Court, which he says has a rule that if any judge fails to publish a judgment, the court’s adjudication committee will demand to know the reason why. “I think it’s a wonderful development,” he says. “It increases transparency. It shares experience and wisdom. And it restrains free discretion to some extent. After all, you don’t want to make a decision that is contrary to another hundred cases decided by your peers.”
Satisfied with law firms in China?
“Law firms need to assign a seasoned partner to ensure that they take individual responsibility to supervise the work of associates and junior partners by reviewing and approving all invoices prior to issuance. The worst impact on a relationship with an outside law firm is for the general counsel or chief legal officer to receive an unanticipated or excessive invoice.”
Gregory Morrow, vice-president and chief legal officer, Contessa Premium Foods
“As the legal regime in China gets more complex, the need for specialization is increasing, and many lawyers haven’t shifted to that model yet, with the result that we find lawyers who are solid in one area who purport to be knowledgeable in others, but who aren’t.”
Sherman Chu, general counsel, Cisco China
“Satisfied with the best (most expensive) firms. Neutral to dissatisfied with advice from lower-tier firms. In the latter case, their analysis is sometimes wrong or terribly unsophisticated.”
Scott Kissinger, legal director – Asia Pacific, Elsevier & LexisNexis
“Not satisfied with US law firms charging US rates for associates with only Chinese language skills and little China experience.”
Vice-president and general counsel, a US manufacturing group
“There are some good local firms, but not many. As a general matter, the quality needs to improve in terms of providing options and solutions.”
Tina Min, senior China attorney, Wrigleys Confectionery
“A lot more expensive than in continental Europe. A lot more time consumed for work that we would consider standard questions and queries. Sometimes there are very many people involved (European partner, Chinese partner, Chinese associate) which adds to complexity of the answer, and the bill.”
Susanne Stollhoff, legal counsel, StepStone Services