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April 7, 2006

Remarks at the ABA, Section of International Law Conference

[I would like to express my thanks to Amy Hirter of Holland & Hart and Bob Brown of Greenebaum, Doll & MacDonald, for inviting me to speak yesterday to the American Bar Association, Section of International Law conference in New York City. I found it thoroughly enjoyable and instructive. My remarks of yesterday follow, with audio to come. You will find the quick links to the "Irrational Exuberance" series towards the end of the post.]

Good afternoon and thank you for having me here today. My name is Rich Kuslan and I’ll discuss aspects of global business expansion, with specific reference to China and to the function of the business attorney involved in that expansion. For those of you with a good deal of China experience, my apologies for what might be repetitive information for you, but, I trust, still worthwhile.

China business is a hot topic. When I first became involved in it, in the early 1980s, only a very few Americans, outside of the State Department and Intelligence, showed much interest in China. Now, it seems, just about everyone, even those who don’t have much good reason to go there, feels that he must put at least his toes in the water. Expansion into China can prove to be a positive and profitable experience.

That noted, the Chinese waters in which we wish to warm our toes usually prove murky and deep. What lies down there and, by the way, how far down? And what can we do, working with our business clients, using our skills and talents, to help them through it and ensure maximum protection?

A brief note on the subject of law in the eyes of a Chinese businessman. The Chinese historically and by preference, have maintained social order and settled disputes, not based upon the rule of law, but upon the situation: party doctrine, power relationships, familial networks, friendships and other factors. In fact, from 1949, when the People’s Republic of China was established, until 1978, there was but one law in China, the Chinese Constitution, virtually no one populating the legal landscape and extremely few legal cases. (That said, Chinese heavily practiced mediation at the local level.) Since the promulgation of the next law after the Constitution, interestingly enough, the Criminal Law, in 1978, several thousand laws and regulations have been passed in a frenzy to provide the legal framework for a changed society, from one in which law and procedure was traditionally of little value to one in which they have gained in importance.

But still, there remains a tension in Chinese business society – Chinese in business consider the law only as the merest afterthought, for example, when government approvals are needed, and approach the law with resistance. More recently, viewed as a weapon to gain an advantage over a perceived combatant. Legal considerations are not usually a main ingredient in business planning, certainly not to the extent it is in the west. This is the thinking in the heads of the Chinese executives with whom you may find yourself dealing.

With this preface, I’d like to offer two guidelines you might want to take with you into the Chinese business environment.

1. In China, valuable information is always withheld.

This becomes very important when doing due diligence on a possible partner or distribution channel.

For example, it is common for a Chinese business enterprise, even state-owned behemoths ostensibly under the purview of the state or national government, to have two sets of books (or more), one (most likely accurate) for the use of executive management and the other for the tax authorities. This is common practice – but the official tax return that you are given during your review may not be reliable – so, will you become liable for tax avoidance penalties? Or perhaps there are debts owed by the company, but not included in the public set of books. You may find these debts have now become payable by you.

Important information – more accurate than the books to be given over to the Tax Bureau and thus of greater value – has been secreted. The idea that valuable information is always withheld permeates mainland Chinese society and makes the job of, for example, due diligence, that much more difficult. In passing, I note that where this idea tends to dissolve is in the trusted personal relationship between confidants, one in which valuable information is often shared.

A subset of this guideline is that any information that has any worth is considered valuable and thus confidential. But beware, you might be told information is confidential because it doesn’t exist.

To show you this in practice and also to demonstrate how tightly Chinese businessmen hold what we’d consider ordinary information, I give you a common example in business relating to routine information. The salesman in China, having been one myself, who asks the potentially helpful question of his customer what his plans are for the year upcoming, so that he can sell in the right product for the need or want, usually gets the response that it is none of his business to ask for such confidential information. And none is usually given, at least none that is reliable, and often because no plans have been made. One might think that, when searching for the right distributor, for example, where the power balance generally tips towards the supplier, that it would be that much easier to demand and receive accurate information. But, alas, it is not. The distributor feels he has every good reason and right to provide only that information which he feels will convince you to select him.

Knowing the guideline that valuable information is withheld, our job is to discover what that valuable and accurate information is. Part of the work involves three things, and here I generalize somewhat, 1) the ferreting out of bits of information from evidence that goes beyond words, such as forensic accounting, independent valuation of physical assets, interviews with employees and 3rd parties, even the rumor mill, etc., which all may give clues to the true situation, and 2) the creation of trusting personal relationships with management of the target, and even those farther down the chain, that enables one to receive worthwhile information from these sources that tend to confirm or deny suspicions, and allow one to pass on persuasive fact-based exhortations to management that might shake loose something more likely approximating the truth, and 3) some experience in the local business environment, so that one knows what to look out for. Note, please, that this work as herein summarized does not always remove the cloud cover completely, and often, you will find yourself working in the twilight, indeed, sometimes you may be in the dark, and not get a clear-cut answer.

As a personal example of a situation that worked out to the benefit of the foreign investor, once in South China I was dealing with Company X, a potential joint venture partner. Over the week I spent with them, I was treated from the start in an overly festive fashion, which put my antennae up immediately. During that week, I was provided with information about Company X which, based partially on my experience, I believed was very likely untrue, specifically their sales projections, which seemed high, and debt levels, which, for a state enterprise seemed very low. The foreign company was to rely upon this information as an important basis for its decision to invest, and I was to verify or disprove it. In passing, I note my conviction that my legal training helped me to penetrate the façade, but more on this later.

My initial questioning of this information brought responses of confirmation that the information they provided was accurate, but supporting information was lacking. Later in the week, I began to delve deeper into their bases for the information provided -- Why do you think you will sell X units of this product at this location? Who are your customers? How many installers do you currently have in that location? etc.-- probing for holes and finding many, becoming more uncertain about this company each day, when, by happenstance, I picked up the local newspaper which on its front cover displayed a picture of a new skyscraper along with an article on its investors, including this Company X, which had stated to me it was involved only in the manufacture and sale of its core products. Their investment in the building was staggering for the company’s size and it was speculative as well. Not wanting to broach this topic directly with the managing director of the company – hoping not to embarrass him, at least not publicly – I showed the article to one of his aides. The aide denied it, and the other aides denied it, and then, perhaps partially owing to the friendly relationship I’d created with the MD but more probably spurred on by the shrinking likelihood of success of continued denials, the MD himself confirmed it. My suspicions about the other information that I had been presented were more than likely confirmed. The western company did not invest in this firm. That was the good thing that happened for the western company in this deal.

A note: whereas Chinese in the 1990s were poorly equipped to deal with foreigners, and generally unknowing of and unwilling to meet foreign requirements for cooperative business enterprises, Chinese in 2006 are comparatively more sophisticated, especially those operating in Shanghai, the commercial center, and in Beijing. (To a much lesser degree elsewhere in China.) Many 100s of thousands of Chinese have returned to work in China from western business and legal education, and experience in western companies. So the chances are that you may come upon someone who understands something about you that will make your job slightly easier. But in most cases you will need to educate them on your requirements for due diligence. I use the term “educate” gingerly. Perhaps, out of respect, it would be better to say that you will “discuss cooperatively.” (What you need and why you need it.) But this does not mean that they will be any more forthcoming than anyone else. Keep those “suspicious antennae” up, even while forming positive relationships. Those relationships may very well provide you with the information you are looking for.

2. Approach China critically

I’ve written at my weblog asiabizblog.com about what may be called the “Irrational Exuberance,” with apologies to Mr. Greenspan, of those who are gung-ho, pardon the pun, about establishing an operation in China, without having done sufficient homework and blinded by a certain mystique that seems to be part and parcel of China, in the eyes of the west. Eyes that often wear rose-colored glasses. (Does that describe your client?) Perhaps less rosy in the eyes of those who have a good deal of experience there, but I am shocked and amazed by those who continue to come back after one trip, declare it a paradise of opportunity without seeing or wishing to investigate the concomitant risk.

Sigh... This is nothing new. What was the content of Carl Crow’s book entitled “400 Million Customers.” Can you guess? And it was published in 1934. Indeed, ever since the Empress of China set sail from the New York harbor in 1784, to purchase tea and silks, China has beckoned, with a mystery and exoticism (to the westerner) that exerts a pull like no other.

The antidote to the mystique is rational analysis, given the facts that one can glean, supplemented by instinct and reliant upon experience. Analysis – the understanding of the truth of the situation -- is an important focus. That is, one asks the right questions, and sees the answers intelligently and objectively without the detriment of unbridled optimism. When the answers are insufficient to form a sensible response – more penetrating questions and more evidence are required. If the result is not something you yourself would be willing to defend in front of your company’s board of directors, it’s insufficient.

In the interests of time, I note that I detail the process of analysis in several posts on asiabizblog.com, and will put up easy links to the series at the home page tomorrow.

[EDITOR'S NOTE: Here are the quick links to the "Irrational Exuberance, or, Should You Enter the China Market?" series:

Number 1: Should You Be Doing Business In China? (Text only)
Number 2: What Do You Wish to Accomplish? (Text / Audio)
Number 3: Where's the Beef? (Text / Audio)
Number 4: A Handsome Bit of Documentation (Text / Audio)
Number 5: Says Who? (Text / Audio)]

And I may as well tell you I have been told that this recommendation I provide to clients insults the intelligence of some. And yet how many companies delve deeply – I mean, really deep -- before committing themselves to China? Does your client?

Management, in my experience, while it may be sharp as a tack, often does not feel a pressing need for in-depth examination of business opportunities, preferring instead to go with the gut, based on some information, showing that they are decisive first and will ask questions and solve problems later as necessary. (Of course, there are exceptions. But that has been my experience.) In any case, managers, generally speaking, haven’t been taught the skills, unlike those with legal training, to establish and understand the facts.

However, in the practical environment that modern China offers us, given its opacity and potential for surprise, the attorney offers precisely those critical and analytical skills that allow for great value to be added to the mix.

You may have already given thought to this aspect of your contribution to your client’s success, or perhaps it hadn’t occurred to you. Even if you have, have you suggested that management make use of these skills in such a way? Perhaps it is possible for you, and in doing so, you will expand the pie by adding more of your intrinsic value, so to speak, to the decision-making process. As an integrated member of a business team formed to plan and implement expansion into China, the attorney, who is trained to establish the facts and look at them critically before coming to conclusions, can help to provide the counterweight of reality.

And that brings to an end my remarks. Thank you kindly.

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