The Japan-China-U.S. Triangle: Competing Partners

April 20, 2010

Carl Cheng
, Partner, Freshfields Bruckhaus Deringer LLP
Henry Liu, Partner, DLA Piper LLP
George Pierce, Senior Vice President and General Counsel, Toyota Tsusho America, Inc.
Timothy Wilkins, Partner, Freshfields Bruckhaus Deringer LLP

Philip Berkowitz
, Partner and International Practice Group Leader (US), Littler Mendelson, P.C.

A distinguished panel of attorneys shared their insights on the dynamic environment that confronts multinational companies doing business in China, Japan and the United States.

This year marks the 50th anniversary of the U.S.-Japan Alliance, but the mood of the two countries has not been celebratory, suggested moderator Philip Berkowitz of Nixon Peabody. "The U.S.-Japan relationship has been consumed with concern" over the Futenma airbase; last summer, Japanese voters ended the LDP's 50-year rule, angered by "the inability of Liberal Democrats to end Japan's nearly two decades-long economic slump and its loss of ground to emerging exporters like China."

"The relationship between Japan and China, just like the relationship between Japan and the U.S., can't be measured in months or weeks," Mr. Berkowitz said. "It must be viewed over decades. And the resurgence of China after decades of being closed to the outside draws parallels to Japan's own experience."

When Henry Liu of DLA Piper (formerly Nixon Peabody) joined the workforce nearly 30 years ago, "bicycles were the trademark of China," and the Chinese economy "was planned from the center going down to the very local levels." The companies in China then were not companies in the modern sense and in fact they were mostly the government's units." There was one bank, the People's Bank at that time; but it basically served as the government's cashier. Farmers and peasants couldn't own land, nor could they farm on their own; they had to work on a commune basis.

The sense of dramatic change came 30 years ago with reform of the agricultural sector, Mr. Liu said. Today, even major state-owned companies have been corporatized; many are now listed on securities exchanges in New York, London and Tokyo. The Chinese government worked to attract foreign investment; the country began to export goods, "now making it one of the largest exporting countries in the world." Foreign investment accounts for over a third of China's GDP.

"China over the last 30 years has geared up very quickly quite a sophisticated, modern legal system, especially in the commercial areas, and also even more so in the foreign investment-related laws and regulations." Basic contract law and intellectual property law have been improved, although IP enforcement continues to be an issue, as it does in other countries.

The Chinese M&A market may be the most active M&A market in the world, and foreign investments into China now go well beyond the greenfield operations that were the focus in early years, he said. Pursuing resources, cost savings and markets, virtually all the Fortune 500 companies have invested in China. most major Japanese financial companies are there as well. Meanwhile, Japan "has been a very, very interesting target country for Chinese companies," due to the cultural ties between the two countries as well as Chinese companies' interest in acquiring Japanese technology.

China's many current domestic challenges include the need to deal with seemingly huge bubbles in real estate and other major types of asset sectors, to manage its foreign currency properly, and at the same time to maintain growth, Mr. Liu said. Whether the new laws will be enforced, and will answer the needs of business in the complex environment of the future, " China certainly needs to make a lot of efforts going forward to make it a true desirable and attractive investment destination with transparency and credibility."

The recently announced joint venture between EMCORE, an American public company in the technology field, and Tangshen Caofeidian Investment Corporation (TCIC) is an example of the innovative techniques China is using to encourage inbound foreign investment, said Tim Wilkins of Freshfields. EMCORE has agreed to contribute its fiberoptics business to a joint venture to be operated with TCIC, which is a state-owned enterprise investment corporation. TCIC is to own a majority interest in the joint venture, and will contribute $27 million in cash and commit to an additional $27 million in funding. TCIC will name the chairman and CFO of the new company; the CEO of the venture will come from EMCORE.

Tangshen, a city of 380,000 in northeast China, suffered a massive earthquake in 1975 and has since worked hard to rebuild, Mr. Wilkins explained. Among the city's efforts is an industrial zone that's been the site of many small investments over the past 10 years. "And so everything, as you will hear about as I discuss the actual investment, is going to be related to how do you keep building this type of industrial zone."

The joint venture with TCIC will establish a site in the Caofeidian industrial zone to manufacture EMCORE's terrestrial concentrator photovoltaics equipment. TCIC has also agreed to provide $3.3 million in RMB-denominated loans, tax and rent incentives for EMCORE to locate its solar panel business in the industrial zone--"a very different type of incentive than you would find for a typical deal of this type," he said.

Not surprisingly, the transaction is subject to review by Chinese and American authorities, he noted. On the U.S. side, the reviewing body is the Committee on Foreign Investment in the U.S., or CFIUS. The critical issue is national security, which is broadly defined to include "critical infrastructure," meaning everything from agriculture, food and water to information technology, energy, transportation, banking and finance, cyber infrastructure and even national monuments.

EMCORE's sensitive satellite communication business is not part of the TCIC transaction, and Mr. Wilkins and his colleagues are quite confident the deal will pass muster with CFIUS. "But we are not so confident that we would just go forward and close the deal without it, because CFIUS has the power to completely unwind the transaction. So, any time you have China and something a little bit sensitive, unfortunately, as you can imagine, it's a huge political football."

A second noteworthy transaction is Geely's purchase of Volvo from Ford, Mr. Wilkins said. Geely is paying $1.8 billion in exchange for the Volvo Car Corporation "plus--and this is key--IP licenses and grants" without which Geely could not make Volvo cars, since they are built using the same platform as Ford cars.

Geely's Chairman and founder is Li Shufu, an entrepreneur whose first venture was a small photo business he started with a high-school graduation present of 100 RMB, Mr. Wilkins said. "He made his first car in 1998, not too long ago. By 2009 he has produced 329,000 cars. He is aiming for 421,000 this year. But in 2015 he wants to make 2 million cars." The company's biggest markets include Russia, Ukraine and Venezuela, "but of course he is looking at the largest automobile market in the world, which is China."

"It's important for people to remember that you have state-owned enterprise approaches that are still quite common in China, but the entrepreneurs are coming and they are carrying a lot of cash," he concluded.

For those hoping to make investments in China, "there is good news and bad news," said Carl Cheng of Freshfields. "The bad news is that the laws continue to be very vague and counterintuitive. The government processes are still very difficult. The good news is that if, as a foreigner, you are prepared to have the patience and jump the hurdles that the laws and the government processes create, it has become much, much easier to get the financial results that you need to justify your investment in China." As GM's experience reflects, "foreigners by and large are doing very, very well with their investments in China."

China began to open up its economy to foreigners only about 30 years ago, and was greatly concerned that "there would be another invasion, maybe another opium war, maybe there would be a revolution," Mr. Cheng said. At first, foreigners couldn't set up shop in China at all, but had to make contract arrangements from Hong Kong. Then the Chinese began to allow representative offices--"one guy maybe with a couple of secretaries who sits in China. He can't do business, but he can act as a liaison. And there was no revolution, there was no invasion. The Chinese said, 'Okay. Well, that's not so bad.'"

The country then allowed foreign manufacturers to set up joint ventures with a Chinese partner. When these ventures went well, "the Chinese said, 'Okay. We'll let foreigners set up 100 percent and wholly foreign owned enterprises.'" This was so successful that "a big chunk of China's foreign exchange--I think as of 2000 most of China's foreign exchange--had been generated actually by foreign companies who had established investments in China.... Now, that has changed since then. But that's how well these investments did in China."

"And now China said, 'We're not doing so bad. Now the country is much stronger. We don't have to worry about somebody coming over with a gunboat trying to open up one of our ports.'" So "China is at the cusp of a stage where they are saying, 'Maybe we will let foreigners come in and set up these foreign invested companies limited by shares'--these are basically corporations, the equivalent of a listed corporation in the U.S.--'where we let foreigners try to raise capital in China.'"

Not every industry is eligible for foreign participation, Mr. Cheng noted. An auto company, for example, has to have at least 50 percent Chinese ownership. Listings of which industries allow foreign investment and at what level are set out in the Foreign Investment Guidance Catalog. Business people must keep in mind that if their business plan changes--let's say they start a pen factory, it doesn't do well, and they want to convert it to make laser pointers--they must apply to the Chinese government for approval before making the change.

Moderator Philip Berkowitz reflected on the complex relationship among Japan, China and the U.S. The growth of China as an economic power has "to some degree threatened Japan's standing as Asia's leading economic power." Japan feels uneasy about the growing strength of the American relationship with China; McDonald's "plans to double its number of restaurants in China by the year 2013; in March, General Motors sales set a monthly record in China, which is now GM's largest market."

Japan and China share much culturally, including similarities in language, respect for elders, and working in consensus rather than focusing on the individual, yet some aspects of business culture may be quite different. In a recent article, Mr. Berkowitz said, the head of JW Thompson's Japan office wrote that "he thought that culturally the Japanese don't bargain, but the Chinese bargain as an entertainment and exercise. Harmony, he said, in China, is a means to an end, but in Japan it's an end in itself." Workers in China surveyed about layoffs said that given the choice between a broad-based salary cut and layoffs of poor performers, they'd prefer layoffs; "but in Japan the layoffs were shocking, and there was stunned grief over that."

George Pierce, general counsel of Toyota Tsusho America, recounted the story of the time a client of his was sued in China in a dispute about fish.

Mr. Pierce's client was a Japanese-owned American company that was being sued for breach of contract by a Chinese company. The allegations were quite simple: "There was a contract to supply fish. The plaintiff had already paid for the fish by letter of credit. They said that the fish were too big. They were out of specification. They wouldn't fit on the plate, and therefore they were inappropriate for the New Year celebration. The plaintiff had been damaged because he couldn't sell all the fish."

Looking into the background of the plaintiff company, Mr. Pierce learned that "the owner of the company was the nephew of a rather prominent general in the Red Army. I thought, 'That's not good.'"

Could the client, which had no assets in China, ignore the litigation and allow the plaintiff to win a default judgment? No, that wouldn't be wise, because the client had affiliated companies in China against which the plaintiff might try to collect.

Should he litigate in China? Too much of a risk that as an out-of-town lawyer, he'd be less persuasive than a local lawyer who appears before the local court all the time.

Could he challenge the court's jurisdiction? Maybe yes. There were strong arguments that under the Chinese law of civil procedure, the case ought to be dismissed for lack of jurisdiction. But how to assert this? In an American court, he could make a special appearance to argue only the jurisdictional point. The Chinese statute seemed to say this could be done in China too. But his Shanghai counsel said, "'No, Mr. Pierce, you should show respect for the court. This is a very nice city, and it's very nice here in the springtime. Please come in person, and you should resolve this jurisdictional issue right away by submitting to the jurisdiction of the court.'"

In the end, it turned out that the fish weren't out of specification. The plaintiff "had bought too much. He'd already paid for it, and he needed to get some money back. That's what was really driving him," Mr. Pierce said. The parties settled the case.

The lesson, he said, was that the advice he'd been given by the Shanghai lawyer was not advice on the letter of the law, on what could be read in the text of the civil procedure statute. Instead, it was advice on "what is the correct, the moral, the right way"--how the statute would actually be applied by the court.

The dispute about the fish took place 15 years ago, and China's approach to commercial transactions is changing, Mr. Pierce added. In 2001, rules of evidence, applicable primarily to intellectual property, were issued in China. Contracts, in Japan as well as in China, are becoming more detailed and more like the typical U.S. contract. Chinese courts recently held against a Chinese Internet service, "which is something that in 1995, when I had my litigation, I never thought we would ever be able to win."


There was time for just one question from the audience:

Would you agree that the Japanese actually have some of the best insights into the business approach and culture of the Chinese?

"We get asked a lot by our American clients and our European clients, 'We are doing business in China. We are having a really difficult time. What should we do?'" responded Mr. Cheng.

Answering such a broad question is not easy, "but one specific thing that I often say to my clients is, 'When you have a problem, there is no need to reinvent the wheel for the solution. Look around to see who has had this problem, and who has overcome this problem in a successful way'"--and in particular, "look to see what Japanese companies have done in China."

Zipper manufacturer YKK is a case in point. Rather than fixate on lax enforcement of IP laws and small damage awards that don't deter knockoffs, YKK takes practical steps to limit outsiders' access to its processes and procedures. "YKK factories are basically big black boxes. They don't let anyone come in and look at their factories.... They say, 'Some MBA professor calls you up and you say to bring your students over and take a tour of our factory. Do you know how much you learn by taking a factory tour? You find out who my best employees are. You find out who I buy my supplies from. You look at the equipment and you find out who makes our equipment. Look at all this stuff you find out just by walking through my factory. We're not going to let anyone do that.'"

YKK also holds onto the expertise of its senior employees by virtue of its cradle-to-grave employment policy. "'The reason we do this is because look how much you learn by hiring away one of our senior engineers,'" a YKK China executive told Mr. Cheng. "'All of the stuff we do--our technology is 50 years old. It's not really that difficult to make a zipper. But we still beat all our competitors, because it's what is in the head of that senior engineer.'" In this, Mr. Cheng concluded, China and Japan are closer than China and the U.S. "If you talk to a Chinese state-owned enterprise, the top thing on that manager's agenda is probably not profits. The top thing on his agenda is probably political security. He wants to be promoted within the bureaucracy. And one of the main drivers of that is how many jobs he protects. Doesn't that sound very similar to Japan?"

--Katherine Hyde
Topics:  Business

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