China’s economy is recovering from the pandemic ahead of the rest of the world, but in-house counsel now face an increasingly tense international political theatre and an enormous uptick in regulatory and compliance-related work. Senior counsel share their coping strategies and predictions with Luna Jin
Despite years of legal education, overnight we may have to go back to law school all over again,” jokes one veteran practitioner on his social media. What he refers to is the enactment of the China’s Civil Code during the country’s “two sessions” – the plenary sessions of the National People’s Congress (NPC) and the National Committee of the Chinese People’s Political Consultative Conference (CPPCC) – this year.
The codification, dubbed “an encyclopedia on social life”, is immense in volume, with 1,260 articles covering legal provisions in personality rights, property rights, contracts, marriages, inheritances, tort and so on. The Civil Code will officially come into force on 1 January next year and replace nine separate laws, which will be repealed.
The rules of business activities are set to undergo great changes, and for corporate counsel, 2020 is now on the wane, leaving them only four months to prepare for this new legislation.
Apart from the Civil Code, they also face challenges from supply chain, regulatory environment, and internal team management, according to the recent survey by China Business Law Journal. Fortunately, most have already begun the deployment of precautions in earnest.
Vast new codifications
Unlike European countries, where civil codes are formulated against the formation of nation-states and social change, China has no civil law tradition. At the beginning of China’s reform and opening-up, the legislature then believed that China’s social life was still undergoing great uncertainties, and the country was not equipped with the realistic conditions to formulate a complete codification. Therefore, China chose a path of “from separate laws to one compilation”.
Now, the central government believes the time is ripe. Mirroring China’s economic development philosophy of “crossing the river by touching the stones”, the path of legislation is full of pragmatism. Practical issues, experiences and new phenomena arising from socio-economic development have been properly addressed and fully incorporated.
Title on Contract
The Title on Contract is the largest part of the Civil Code. Compared with the current Contract Law, it simplifies contract rules, adds four types of contracts, such as contract of guarantee and factoring contract, and adjusts the provisions on the validity of the contract, the termination of the contract and the guarantee system. This means that inhouse counsel will need to review their contract templates in use, and their internal risk control process.
Validity of contract
The Civil Code deletes the five types of invalidity of contracts stipulated in article 52 of the Contract Law, making “violating public order and good custom” the possible catch-all cause.
Although the Civil Code does not define what “public order and good custom” means, nor list any illustrative explanations, the contract shall be found to be invalid if it violates “financial security, market order, state macro policies, etc.,” as per the Minutes of the National Working Conference on the Trial of Civil and Commercial Cases by Courts and other provisions of the Code.
This principle will be of great significance to China’s financial industry, where many rules are yet to be determined. “There is no denying that financial business is innovation-driven by nature,” says Li Chaotian, general manager of the legal and compliance department at Generali China Asset Management. “In the process of business innovation, whether it conforms to the principle of ‘public order and good custom’ will become one of the criteria for compliance risk evaluation.”
Linda Ma, senior legal director of online education platform 51 Talk, adds: “The principles of fairness, autonomy of will, equality, integrity, and public order and good custom advocated by the Civil Code not only specify the overall protection of rights, but also set the reasonable boundary of rights, which will help promote the normative conduct of market players and the realization of civilized order.”
Termination of contract
The provision that would grant the breaching party the right to apply for termination of a contract was initially deleted in the draft, which sparked fierce controversy, so it was retained in the official version. This disputed provision is intended to break contract deadlocks commonly seen in practice.
In order to prevent the breaching party from abusing this right and evading the performance of non-pecuniary obligations, it is necessary for enterprises to take precautions in the part of liability for breach of contract, and set up special liquidated damage clauses for the possibility that the breaching party “applies to the court for discharge of contractual rights”, as stated in the Civil Code.
The Civil Code adjusts the provisions on contract of guarantee and mortgage contract, explicitly establishes the legal effect of the contract of guarantee as a subordinate contract, and no longer allows the independent validity of the contract of guarantee to be established by contract agreement (except for the letters of guarantee of financial institutions).
As a result, the workload of in-house counsel may suddenly increase. “For normal businesses, we will need to adjust the relevant terms of existing conventional contracts,” Li says. “At the same time, it will implicitly impose an influence on the validity of the master claim/debt contract. All the evaluations on the validity of the contract need to be re-examined according to terms and chapters of the Title on Contract of the Civil Code, and we need to adopt new methods on the risk control of business operation.”
In the short run, Li says, this will constrain efficiency and increase costs for transactions to a certain extent. “With new transaction habits taking shape, however, the impact will gradually decrease,” he says. “These changes will encourage insurance asset management institutions to pay more attention to the validity of claim/debt contracts and the operational process in ensuring the validity of contracts, apart from attaching great importance to credit risk and credit enhancement measures.”
The protection of property rights in China started relatively late, and even the General Principles of the Civil Law, passed in 1986, did not adopt the concept of property rights. Then, in 1995, China passed the Guarantee Law.
At the beginning of the Civil Code era, the social economic background of China has transformed greatly. Accordingly, the code expands the scope of secured property, stipulating that “existing and future receivables” can be used as collateral. Meanwhile, the Civil Code permits the transfer of mortgaged goods, helping the mortgagor make better use of them. In addition, the code stipulates the order of repayment, in articles 205 and 206.
These changes are precisely designed in response to the urgent financing needs of Chinese enterprises, and to revitalize the movable properties of enterprises. According to International Finance Corporation (IFC) calculations, the movable properties available for security in China are worth between RMB400 trillion (US$58.46 trillion) and RMB600 trillion by 2019. Yet about 80% of the guaranteed loans are still secured by immovables, making these movables de facto “dead capital”, a survey of the State Council’s Development Research Centre stated in 2018.
In order to be in line with international practice, the Civil Code refines the transaction rules for movable assets in the Title of Property Rights, which lays a foundation for the establishment of a unified registration system in the future. In the Civil Code, the registration and delivery of movable assets are of equal validity. In the event of a conflict, the chronological order of their occurrence determines which one has priority validity.
Right of habitation
In Western countries, the “house for pension scheme” (a reverse mortgage loan) is a very common and mature retirement model. In China, however, the public does not trust this model because of frequent scams and the lack of a legal basis when it comes to their protection.
Based on the existing Property Law, the Civil Code introduces the concept of “right of habitation” and establishes it as a usufruct – a legal right accorded to a person or party that confers the temporary right to use and derive income or benefit from someone else’s property. Li believes that this will bring in fresh development opportunities to the insurance industry: “The establishment of the right of habitation will have a positive impact on the development of insurance business and asset management business related to the house for pension scheme.”
Personal information protection
In the Title of Personality Rights, the Civil Code, by dedicating a special chapter on “privacy and personal information protection”, for the first time establishes the right to privacy as a personal right parallel to other basic rights such as the right to life, the right to example of provisions on “personal information processing” from the EU’s General Data Protection Regulation (GDPR), stipulating that “collection” of personal information is also included within the scope of “processing”.
These regulations are of great significance to technology companies. “Article 111 of the Civil Code, on the protection of personal information, puts forward more and detailed compliance requirements for the online education industry,” says Ma, of 51 Talk.
Parallel to the protection of personal information, articles 999 and 1036 stipulate the fair use and exemption scenarios, which support enterprises to develop big data technology reasonably and legally.
For the development of artificial intelligence (AI), the codification is devised to guide its development. Article 1033 lists prohibitions in privacy protection, specifies typical scenarios of privacy protection, and draws a red line for AI technology to interfere in human life. Article 1019 clearly states that, “the right to portrait of others shall not be infringed [by methods] such as forgery using information technology”, which directly refers to deep fake AI technology.
Ma suggests that enterprises should “improve the infrastructure construction for their own data protection and increase technology investment, revamp their rules of personal information collection, and use strictly in accordance with laws and regulations, and standardize the behaviour of collection and use”.
Li believes that this voluminous codification summarizes and unifies existing laws, judicial interpretations and legal precedents, reduces many conflicts in application at the legislative level, and will help compliance teams assist their companies in carrying out business and avoiding risks more effectively.
The recurrence of pandemics, coupled with rapid changes in the international political environment, have brought many risks to the global supply chain. Among them, the political wrestle between China and the US has had a direct impact on the fate of well-known Chinese enterprises such as TikTok and Huawei.
The corresponding risks put the gatekeeping of in-house counsel to the test across business sectors. “On the one hand, the economic downturn caused by the pandemic has seriously affected the yield of real estate,” says Valiant Wei, legal associate director at Chinalife Capital. “For example, some tenants threw their leases, and some tenants wanted to renegotiate the lease through force majeure and other legal terms. On the other hand, the instability of international relations has created potential risks for the overseas investment structure, and the security of overseas asset holding platforms.”
Due to the strict prevention and control measures in the early stages of the pandemic, China’s economy has taken the lead in recovering, even as many companies record drops in economic performance. A Reuters poll in July raised its forecast for China’s GDP growth in 2020 to 2.2% from April’s 1.8%.
“Because of the pandemic, the supply chain of Lenovo is facing great challenges,” says Gao Huandong, vice president and general counsel of Lenovo. He offers some advice on how to assist companies to resume production: “The legal department needs to closely monitor the administrative regulations of the affected areas, urge business departments to comply with local pandemic control requirements, and assist business departments in applying for restarting their business.”
Liu Fang, vice president, general counsel and chief compliance officer of NIO, shares her experience: “Our legal team reviews the possible risks of late delivery of orders from suppliers and clients at the first instance, so as to ensure the orderly progress of supply and production.”
For enterprises with business in many countries, in order to manage risks from multiple sources, Liu says the key is to establish a unified risk control system. “Since NIO went public, we have rapidly built a global compliance system, promulgated various compliance policies and procedures for a listed company, and organized online and offline compliance training at all levels of the company on a regular basis.” On 6 August, the White House announced a plan that requires Chinese companies listed in the US to comply with US accounting standards. If they fail to comply by 2022, they will be forced to delist.
Some believe that gradually intensifying tensions will eventually lead to a decoupling between China and the US, in which case multinational enterprises will accelerate the transfer of their supply chains from China in order to avoid risks.
What is the feasibility of a large-scale transfer of supply chain from China? In a report published in July, S&P Global Ratings says that “the potentially prohibitive costs of alternative manufacturing, the lack of an efficient labour force elsewhere, and the need for readily available raw materials/resources” make it impossible for US manufacturers to abandon their dependence on China.
“Tech firms may be doubly reluctant to relocate their manufacturing footprints at the cost of potentially alienating and losing access to China; the world’s second-biggest economy – with its burgeoning middle class and increased urbanization – has become an important end market for goods such as smartphones, laptops and commercial IT products,” the report says.
Eric Xie, vice president and chief legal officer at Foxconn Industrial Internet, notes: “Personally, I think a complete decoupling between China and the US … will never be achieved. Many companies (even universities) have been added to the ‘entity list’ of the US. However, compared with the overall scale of China’s economy and the number of enterprises, they are still a very small portion. Therefore, I think the decoupling will only happen on some issues, and in limited areas, but not in all business areas.”
Xie says it is predictable that in the short term, there will be no sign of any fundamental improvement in the relationship. “Therefore, it is necessary for the legal team to prepare in advance and put more effort into recalibration on this issue.”
Other important legislation that will come into force on 1 January 2021, at the same time as the Civil Code, includes the Regulations Concerning the Hygiene Supervision over Cosmetics. Zhou Le, legal director of the legal department at Oriflame (Greater China), says the introduction of the regulations “marks that the regulatory focus on this industry in China is shifting to ‘post-listing’ supervision”.
Zhou predicts that in the near future there will be a lot of implementation rules coming out, or a draft of the official law. “Based on the understating of the provisions, we need to analyse the regulatory trends and come up with specific guidebooks for various internal business departments. For in-house counsel, this not only requires a solid professional knowledge and understanding of the business, but also the ability to play a leading and communicating role in the internal co-operation of various departments.”
Specifically, for actions that involve cross-sectoral co-operation, Zhou suggests that the legal department should sort out the following items in the first place: (1) an analysis and interpretation of specific provisions; (2) The possible work of the relevant business departments involved; and (3) matters such as possible resource allocation.
Due to the different characteristics of industries, in-house counsel will have their own focus. “For online education, laws and regulations, and implementation, industrial rules updates are constantly changing, iterate rapidly, and have distinct industrial characteristics that require good practical judgement from in-house counsel,” says Ma
Counsel from the new energy automobile industry and the venture capital industry share similar interests when it comes to regulatory focus. “Because of the huge capital demand of the automobile industry, laws and regulations, supporting financial and taxation policies related to bank financing and listed companies are the focus of our attention,” NIO’s Liu says.
In addition to regulations on private equity fund management, Xiong Guihua, vice president of Qianhai Fund of Funds, also pays close attention to the policies and regulations on listing and tax incentives for venture capital (VC), “because it involves compliance and withdrawal, which are the top priorities for VC”.
For the compliance teams of financial companies, in-house counsel play a bigger role in monitoring the regulatory environment. Generali China Asset Management’s Li says that since the team’s focus on macro-policy research is closely related to the company’s main business direction, strategic planning and annual plan, “the company rarely relies on external lawyers for professional opinions. Instead, issues are mostly solved with us internal counsel taking the lead”.
China is at a special historical moment. Internally, the speed and quantity of its legislation are rarely seen elsewhere in the world, and the legal regime is improving with every day. Externally, the country’s rapid economic development has situated it at the forefront of the international arena. For enterprises, all these factors not only bring great opportunities, but also unprecedented challenges in professional knowledge and adaptability to legal developments.
Wang Qingyan, general counsel of state-owned enterprise Yunnan Provincial Energy Investment Group, says the biggest challenge lies in “the inconsistency in levels of corporate governance, team capability and compliance construction among the group and its affiliated companies”. In order to cultivate a legal culture, she shares the improvement approach of her company, setting up a legal consulting room and compiling internal legal research publications.
Faced with constantly updating legal knowledge, Cai Weili, general manager of the legal department at Focus Media, says: “From the management point of view, we have increased the ‘rotating internal training’, whereby one colleague is assigned to studying one issue, and then he/she will teach the rest of the team. The effect is very good.”
For in-house counsel, it is a difficult task to fully understand both the law and the industry. Zhou says on-job training is very important. When building the legal team, Foxconn’s Xie encountered the same problem. “Legal professionals with industrial knowledge are hard to find in the talent market,” he says. “Many candidates have acquired various qualifications, but these certificates don’t represent practical experience.”
Xie also points out that frequent job-hopping, the ability to do foreign-related work not matching academic qualifications, unrealistic salary requirements, etc., are among the great challenges when putting up a legal team.
In terms of the geographical distribution of talent, Xie observes that “high-end legal talents in mainland China are still mostly based in Beijing and Shanghai, while there are fewer of the them and not enough for Shenzhen and Guangzhou”. Xie thinks that this phenomenon is related to the unbalanced development of cities and the uneven distribution of social resources (such as children’s education, medical resources, etc.).
Shawn Zhao, vice president and general counsel of Schneider Electric (Greater China), also faces the challenge of “hiring and keeping talent, and grooming them for larger roles within a relatively stable organization”. He says it is important to “provide room for growth and training to update their knowledge”.
In terms of team integration, Amy Liang, legal director at Keep, China’s well known online fitness platform, points out that different generations of counsel have different work styles and personalities, which will bring management challenges.
“By understanding strengths and weaknesses in everyone, I will adopt a more targeted training mode, commit with full trust, discover able people and put them in suitable posts, and give everyone the opportunity to take charge, which will make them more conscientious about their work,” says Liang.
One subtle but important dynamic within a company that is often easily overlooked is how the legal department should communicate with other departments. “In-house counsel are often challenged with how to balance the company’s business development and compliance,” says Duan Xiangwei, general counsel at China Machinery Engineering Corporation (CMEC). “In our experience, while daring to say ‘no’, in-house counsel should also provide various solutions when solving problems for business departments, so that we can sustain the balance between business development and compliance.”