Issue July 2005

Peeling the Onion provides an in-depth analysis of the major issues facing multinationals doing business in China in today's environment.
It features a regular update of regulations, taxation, business environment and accounting legislation affecting foreign invested enterprises in China.

The Debt Collection Climate in China

The history of Debt Collection in China has an underlying theme of corruption and immense difficulty. Prior to the State Administration for Industry and Commerce and National Public Security Bureau regulations issued in 1995, both professional debt collection agencies and law firms were allowed to collect debt in China. Unfortunately, tactics such as violence, intimidation, and other forms of scandalous corruption were prevalent in debt collection agencies. Due to such methods, professional debt collection agencies are now considered void under Chinese law. Even more troubling, such agencies are not subject to legal recourse if they decide to refuse to return the debt to the creditor. Law firms and arbitration teams are thus the only viable and legal resource in assisting a company with their debt recovery.

Unfortunately, much of the business climate in China regarding debt collection still exists. Many Chinese companies who purchase goods from foreign companies lack the capital to pay for the already ordered goods. Due to lack of company transparency and fraudulent accounting books it is difficult to judge a Chinese company’s credibility. Also, many companies in China have to pay their own debt while at the same time waiting to receive payments from their own costumers thus unable to afford the payments to the foreign enterprise. This infamous predicament is called “triangular debt.”

Occasionally Chinese companies will attempt to take advantage of the foreign enterprise by avoiding debt payments for as long as possible even if they are able to make the necessary payments. Chinese companies are able and willing to do this for two reasons. First of all, the statutory limitations on when the creditor can collect the debt is two years. After two years, the debtor is no longer subject under Chinese jurisdiction to pay the creditor. Most debtors make payments to the foreign enterprises after they have distributed all of the purchased goods. Usually, both the foreign enterprise and Chinese company have signed a contract beginning at the start of distribution. This gives the creditor less time to collect the debt in the already short statutory period.

For example, if a creditor begins the contract of a fixed credit payment three months after delivering the goods, the creditor has already lost up to three months of time in the limited statutory period. In the cases where the statutory period for recovering the debt is tightened by the avoiding Chinese debtor, the creditor must and can extend the statutory period. In the past, many creditors have issued a deadline to the Chinese debtor along with the threat of a lawsuit if the debtor fails to pay. In order to extend the statutory period of debt recovery, the creditor needs to show proof of extension through a note or a letter allowing the debtor to have a lengthened dateline. After one year, the profitability of a successful debt recovery declines substantially so, it is in the best interests of the creditor to act swiftly when beginning the process.

Integrating an Efficient Business Strategy

In order to smoothly and tactfully collect the debt, a company must be sure to integrate their business strategy carefully in order to ensure a successful long-term business career in China. A foreign enterprise must attempt to preserve the relationships that are necessary while cutting off the relationships that hurt the company’s profitability and credibility. The most successful methods for doing this involve litigation and arbitration.

While arbitration is the most common method in collecting debt in China, litigation is also quite efficient and diplomatic despite the underdevelopment of the Chinese legal system. If effective litigation is to be carried out, a company must carefully integrate the litigation process into the Accounts Receivable Management (ARM) process of the company. Some common and strategic steps in fostering the integration involve evaluating the contract provisions to enhance recoverability of delinquent debt, structuring contracts with the sales staff and distributors sequentially linking incentives and commissions to collected payments rather than raw sales totals. Regardless of when debt collection becomes a serious issue employing effective billing procedures using organized computer databases, programmed response system of notices and reminders to the debtor’s payments will emphasize a message of competitiveness and seriousness to the potential debtor. It is important to convey to the sales and distribution staff that the quality of collection the debt is of higher significance than the quantity of sales. This will ensure accountability for the quality and quantity of sales and related measures.

Unfortunately, it is often difficult to contact the ones responsible to initiate payment in a Chinese company due to the management structure. The “silo effect” or “top down” management, places the responsibility of important payment decision making on the highest management ranks. In order to perform effective billing notification, it is important to contact top-level management and establish a working relationship in hopes of receiving payments.

The Importance of “Guanxi”

Successfully synergizing the litigation and Accounts Receivable Management processes is merely one step of the pre-litigation strategy. Assessment of the litigation team itself is also a crucial in ensuring the effectiveness of legal recourse in China. Underlying themes of corruption litter the legal and political systems, so retaining veteran legal counsel who is well connected with the government can ultimately lead to a successful debt recovery. Often, debtors in China will be linked to local government through payoffs or employment incentives thus giving the debtor aid in the deferral of the debt collection. In these cases it is important to have experienced legal counsel who is highly interconnected with local and top judicial administration especially if the debtor is a State-Owned-Enterprise (SOE). Currently Chinese law firms are the only firms who have the influence needed to be successful in the debt collection litigation. The interconnectedness or relationships in China, otherwise known as “Guanxi” plays an integral role in conducting business in China. Establishing “Guanxi” with upper level management and government officials is one of the first steps in building a successful corporate career in China. It is implied that once “Guanxi” has been established, both sides of the relationship are obliged to reciprocate assistance when asked. In the case of dealing with a debtor, influence impressed on the debtor by the Chinese side could aid in fostering debt recovery. At the same time, a positive business experience might encourage others foreigners to invest in similar areas and sectors in China thus facilitating growth in a local, provincial, or national economy.

While pressuring the debtor is one way to use one’s “Guanxi”, is sometimes advisable to work with the debtor in recovering one’s payment. This can work if the creditor feels the debtor has the ability to pay off the debt but needs an extension or a rescheduling of the payment deadlines. Depending on the debtor’s history of credit analysis, the creditor could help the debtor acquire a loan from a bank or in the case of “triangular debt”, assist the debtor in recovering debts owed to them through company’s who owe the debtor past payments. Regardless of how cordial the chosen debt collection methods are, evaluating the politics in the nascent stages of the recovery process is critical.

Litigation

Only Chinese attorneys are legally allowed to represent foreign enterprises within a Chinese court thus making it impossible to retain both foreign law firms established in China and foreign law firms based offshore. Once the litigation process begins, it can actually be quite short and convenient if the right strategic steps have been taken.

On average, the process does not take much longer than 6 months to reach a verdict and depending on the amount of debt collected, the fees for the legal recourse can be quite cheap. The court filing fees can range from 1% to 3% if the claim exceeds 1,000,000 RMB. The law firm fees can vary anywhere from 20% to 30% of the amount collected and if hourly rates are instated then the attorney will charge up to $300 per hour.

Documents needed in a Debt Collection Case include the Civil Complaint, a Power of Attorney, an Evidence Preservation Application, bank account statements, underlying documentation of the transaction such as sales contracts invoices, shipping records, bills of lading, support business correspondence, a Pre-Asset Preservation Form, and a Litigation Asset Preservation Application.

The Pre-Asset Preservation Form is one of the most crucial yet overlooked documents consulted within the litigation process. Often, upon the receipt of the summons concerning the debt owed, the debtor will use devious means in attempt to conceal his assets if there has been link between the debt owed and the debtor’s bank account. In order to preserve transparency, law firms will often advise the foreign enterprise to apply for both the Pre-Litigation Asset Preservation and Litigation Asset Preservation. A company can apply for both prior to filing the civil complaint and can go into action to freeze the debtors assets within 48 hours of passing. If there is similar concealment of other items related to the debt collection proceedings, then a company can apply for Evidence Preservation. Hearings for situations involving such complaints usually occur within 1 month of filing the complaint.

It is important to pursue both debt collection through legal action as well as using one’s political influence. Putting pressure on a debtor from both sides curbs the debtor’s chance to avoid payments and often results in a successful debt collection process. Integrating both methods into a company’s Accounts Receivable Management scheme is vital in sustaining the balance of one’s business strategy in China’s often-overwhelming business climate.

Arbitration.

The most widely practiced method in collecting debt in China is Commercial Arbitration. The China International Economic and Trade Arbitration Commission (CIETAC) is the governing agency regarding arbitration between international, domestic, Hong Kong and Macao, and Taiwanese companies. In order to hedge risk, it is often advisable to include an arbitration clause in the company’s sales contracts thus allowing potential trade disputes to fall under the jurisdiction of the CIETAC. The CIETAC first issued a comprehensive set of arbitral provisions in 1994. The CIETAC’s May 2005 reissue was a more effective and international set of arbitration rules and remains the basis for Commercial Arbitration Procedures in China.

The CIETAC is headquartered in Beijing while having subdivisions in Shenzhen and Shanghai. All three are responsible for accepting, replying, and disputing arbitration cases in China. In cases where a company has contract that provides for arbitration by the CIETAC, both companies are unanimously subject to arbitration administered by the CIETAC. If two companies agree to modifications of the CIETAC rules, then such modified rules can be applied thus rendering the CIETAC uninvolved. But, most companies adopting Commercial Arbitration for debt recovery in China adhere to the rules issued by the CIETAC. When utilizing the CIETAC legislation, in terms of debt collection, the creditor must sign a written arbitration agreement or clause through email, letter, contract, fax, telegram, or any other tangible documents. The arbitration commences on the date that the CIETAC receives the request for arbitration from the respondent. Once the arbitration agreement has been signed, the CIETAC has the power to judge the application’s validity and jurisdiction. When and if the application is accepted, the CIETAC will issue both the creditor and the debtor a ‘Notice of Arbitration’ that includes the CIETAC Arbitration laws, the members on the Panel of Arbitrators, and the Schedule of Arbitration Fees. Within 45 days of receiving the ‘Notice of Arbitration’ the respondent can file a Statement of Defense which includes the evidence, facts, and foundation for which the defense is needed. The respondent can also file a statement of Counterclaim which includes facts and reasons for the counterclaim. During this time period the claimant and counterclaimant can amend their claims and counterclaims as long as the arbitral proceedings are not delayed.

Both parties will agree upon the place of arbitration and language used during the arbitration process. Either foreign or Chinese attorneys can represent both parties involved in the arbitration. The arbitrators, on the other hand, are appointed by the two parties from the panel of arbitrators provided by the CIETAC. Each will choose one to three arbitrators as candidates. If the parties cannot come to an agreement on submitted arbitrators or none of the candidates are jointly agreed upon, the CIETAC chairman will decide for the claimant and respondent. The appointment of arbitrators is usually done within fifteen days of the claimant and respondent’s receipts for the ‘Notice of Arbitration’ thus providing for a more cogent arbitration process. Complications may arise when there are more than one claimant or more than one respondent. In these cases, the CIETAC chairman will also take responsibility in appointing an arbitrator from the CIETAC panel. If the chosen arbitrator is challenged by either party, which often occurs, the arbitrator is then removed from the panel and replaced. Once an arbitrator has been agreed upon, the parties will hold oral hearings which both parties will be informed of twenty days prior to the scheduled hearing. Occasionally a private review of the documents is opted rather than an oral hearing.

According to the CIETAC regulations, the arbitral award will be given within six months from date that the arbitration tribunal is formed. The process can be extended if the arbitration team feels that it needs more time. Once the award is issued, it is binding. After this time it is impossible to file law suits or make special requests in the issued award.

Conclusion

The litigation and commercial arbitration processes can be relatively swift and effective for collecting debt in China. If litigation is the chosen method, it is essential that pre-litigations measures are carefully planned and cogently integrated into a company’s Accounts Receivable Management process. If arbitration is advised and preferred, a company’s success lies in its close understanding of the arbitration procedures. China is still a developing economy and the business climate is often volatile and opaque. In order to hedge one’s risk, a company must understand the debt collection process when doing business in China.

The Chinese State Administration of Radio, Film and Television (SARFT) issued Administrative Rules on Local Foreign Affairs of the Radio Film and Television System, Chapter2, Article 7th on July 6, 2005. This is a new regulation, which further restricted the China media industry. Thereby, the cooperation that has been started early this year between Qinghai Satellite TV station and News Corporation has terminated.

Even if foreign firms can establish a joint venture with domestic TV, film, radio companies, the regulation specifies that they do not have the right to cooperate in channel operation and in live programmes. It is also infers that local media cannot rent their channels to foreign firms.

The SARFT will control and approve any other kind of cooperation.
Source: Xinhua News Agency

Zero Tariffs for all made-in-Hong Kong products

The third phase of CEPA, the "Closer Economic Partnership Arrangement" between Hong Kong and China's mainland, is scheduled for January 1, 2006, uncovered Mr. Wang Liaoping, the director of the Taiwan, Hong Kong and Macao Affairs Department of the Ministry of Commerce. This phase will set up tariff free treatment for all made-in ¨CHong Kong products when being exported to China¡¯s mainland.

For the manufacturing sector, an additional 300 categories of Hong Kong products would enjoy this zero tariff agreement.
For the service sector, Hong Kong services firm would be able to invest in more industries in China's mainland. It will give them an advantage over their foreign rivals.

From the implementation of the CEPA, January 1, 2004, to the first quarter of 2005, investment and trade volume between Hong Kong and mainland have increased.
In the first quarter of 2005, while mainland's import from Hong Kong reached USD 40 billion, mainland's exports to Hong Kong reached USD 33.7 billion.
Source: Qianlong

ACFTA process has started

"Agreement on Trade in Goods of the Framework Agreement on Comprehensive Economic Co-operation between PRC and ASEAN", which was signed by China and Association of Southeast Asian Nations (ASEAN) last November, has entered into force this July 1. Meanwhile, the Most Favored Nation (MFN) tariff lines have been classified into two groups, the Normal Track (about 7,000 sorts and whose tariff rates would be gradually reduced and eliminated) and the Sensitive Track (the rest and whose tariff rates would retain within proper ceilings).
According to the agreement, the two sides should reduce the tariff rates to less than 5% for more than 40% of the tariff lines in the Normal Track by July 1, 2005. For the rest of the tariff lines, the deadline is January 1, 2007. After Jan.1 2007, all the tariffs in the Normal Track should be eliminated by January 1, 2012. From July 1 to July 20, 2005, China and the ASEAN 6 (Brunei Darussalam, Indonesia, Malaysia, the Philippines, Singapore and Thailand) had a chance to examine the implementation of each other¡¯s tariff reductions.
Also,MFN tariffs have been granted to the two sides by each other and ASEAN-China Free-Trade Area (ACFTA) has been implemented. According to an official from Chinese Ministry of Commerce, the trade volume of ACFTA this year may reach $100 billion.
Source: Sinocast

WTO Dalian Meeting Considered Failure?

Important WTO members recently concluded an informal meeting in Dalian. WTO Director-General, Mr Supachai Panitchpadki, openly expressed "grave concern" about the state of the negotiations. Supachai said, "WTO members must work harder to reach a consensus on issues having to do with reducing government support for farmers to opening their markets to foreign services such as banking". Too many unresolved issues would almost certainly doom the Hong Kong talks this December to failure, he said. Source: Business Line

Ministers gathered at the meeting were optimistic that they could make progress after the European Union and the United States expressed support for the G-20 proposal on market access in agriculture. EU Agricultural Commissioner Marianne Boll Fischer said: "We are willing to develop the structure of an agricultural market access formula using the G-20 proposal as a starting point". And the US, a votary of the Swiss formula, which had been strongly opposed by the G-20 and the developing countries, conceded that the G-20 proposal was a "positive contribution".Adapted from Asia Pulse

However, as Supachai said on July 8: "It is true that some progress has been made in certain areas of the negotiations. But let us be clear: this progress is nowhere near sufficient in terms of our critical path to Hong Kong, and it is not being seen in the key issues which would help unblock progress across the board. Overall, there seems to be a renewed sense of blockage and frustration. We are also seeing a resurgence of sterile debate about process, rather than negotiations on substance". Cutting through the haze, he added: "I am afraid we have to face the facts. These negotiations are in trouble".
Adapted from Business Line

On 14 June 2005 the Chinese authorities amended the administration of employment permits for nationals from all three territories working on the mainland.
The new regulations comprise changes of social security and employment permit and they take effect on 1 October 2005.

Social security changes:
¡¤Citizens of the Hong Kong, Macau and Taiwan working in the PRC will now be liable to social security principles. If employees are working for more than three months on a cumulative basis in a calendar year, the new rules apply.
¡¤Accordant to Chinese guidelines, contributions will be administered by the Ministry of Labor and Social Security.

Employment Permit changes:
¡¤Applicants from the three territories now face stricter age limits
¡¤Definite specification of the documents that have to be presented by an employer to obtain work permits for nationals of the three territories. The demanded documents encompass inter alia health certificates and proof of professional qualifications

These new amendments pose a considerable influence on entrepreneurs operating in the PRC.

Direction displayed on extension the business volume with distribution of non-commercial Foreign Investment Enterprises

On 2 April 2005 the Ministry of Commerce (MOFCOM) issued a Notice (Shangzihan [2005] No.9) treating the stipulations non-commercial enterprises have to satisfy in order to add distribution activities to their business.

According to the guidance foreign investment enterprises (FIE) have to review the enterprise contract and articles of association and submit several required documents such as the Application Form for Adding Distribution to the Scope of Business Activities of Non-Commercial FIEs or the Application Form for Adding Distribution to the Scope of Business Activities of Investment Enterprises/Regional Headquarters.
These FIEs also have to change the FIEs approval certificate and must indicate the requested form of distribution. Thereby such FIEs have to stick to the precise procedures stated in the relevant rules.
The local branches of MOFCOM will conduct the reviewing process, ensuring the enterprises comply with the regulations.

Increased Tax Burden on Individuals on Real Estate Investment

In May the State Council issued a directive to the relevant authorities regarding a adjustment of the taxation policy of private investment in real property.

Beginning from 1 June 2005, any divestiture of real property by individuals within two years after purchase will affect business tax at 5% on the total sale revenues. In the case the disposal is carried out after two years of purchase a lenient tax treatment will apply.
This means for instance, for ordinary housing is a business tax exemption available.
Moreover, additional criteria have to be fulfilled in order to obtain the business tax exemption, such as the gross floor area of the property should be less than 120 square meters and the selling price should be lower than 120% of the district average selling price of the properties of the same rating.

Due to the variation of the above exemption criteria, it is necessary to check the local demands before ascertaining an exemption opportunity.

Money Brokers Given Limited Opportunity to Trade on the Foreign Exchange Markets

Brokers from financial institutions will now be allowed to work on the currency and foreign exchange experimentally according to the Chinese Banking Regulatory Commission. This will once again proves China's willingness to move toward international financial standards. Although the money brokers merely act as an intermediary for the financial institution, this move by the CBRC will spark further development of the financial markets in China thus enhancing market liquidity and reducing risk. The money brokers will ultimately be allowed to trade foreign exchange products, and loans on tryout basis. Source: China Business Weekly