How Western companies are dealing with China’s corporate laws

Below is a complete transcript of the China Corner Office Podcast with Art Dicker:

Chris: Hi, everyone. Thanks so much for joining us today on China Corner Office, a podcast powered by The China Project, the New York based news and information platform that helps the West read China between the lines.

I’m Chris Marquis, a professor at the Cambridge Judge Business School. Today, we are joined by Art Dicker, a senior attorney at R&P China Lawyers, a full-service, local PRC law firm that advises multinational businesses in China. Currently based in Shanghai, Art has spent the last 15 years working in China, advising technology, manufacturing, and consumer companies on structuring their investments and managing legal risk in their China operations. I got to know about Art’s work through his LinkedIn newsletter on China tech law. I’ll link to the newsletter in the show notes and recommend you take a look.

One of the things I really appreciate about Art’s writing is he takes on some very complex topics and breaks them down in both a thorough and clear and understandable way. In the podcast, we discuss some of these areas, such as how companies are dealing with China’s new data regulations, the VIE, or Variable Interest Entity structure that Chinese companies use to go public in the U.S., and also how the laws governing the VC sector in China have evolved over time. We also discuss what got Art interested in law in China, his interesting career path, and a number of other more general trends in the China corporate law area. Thanks so much for listening and enjoy the show.

Chris: Art, welcome to China Corner Office.

Art: Thanks, Chris. Great to be here.

Chris: Really looking forward to digging into some of the legal issues you’ve been addressing. I’ve been reading your newsletter quite enthusiastically on LinkedIn over the past number of months. We’ll definitely link to that in the show notes. The first question is just a little bit of background. You’ve been a lawyer in China for 15 years now. What motivated you to be on this path?

Art: Well, I’ll try to keep it short, because it can go back pretty far. I studied Chinese in university at Princeton. I studied international politics, and then the language. It actually was triggered from a book I read in high school based on a video game. Romance of the Three Kingdoms is one of the four classical Chinese novels. I was this nerdy kid that played the strategy video role playing game and found out there was a book behind it.

I had that interest in the language and the culture. And then, like a lot of people that go to law school, I didn’t know what I wanted to do, so I went to law school. And then, just combined it all after that. After a couple of years in New York, I went to Beijing and worked at a U.S. firm’s office there, and then went in-house to a U.S. software company that got me down to Shanghai. I’ve been here since and now back at a law firm again.

Chris: Great. I know a lot of content in the newsletters is around the high-tech ecosystem, VC ecosystem. We’ll dig into some of those questions. But now it makes sense that you’ve spent some time actually in-house at a software firm. Can you say a little bit about the firm that you work at now and what type of cases and clients you have?

Art: Sure. The firm is called R&P China Lawyers. We’ve got about 50 lawyers on the team. We’re a local firm, actually, but we focus exclusively on foreign clients doing business in China. Everything in that sense is more or less cross-border investments, transactions, and other things. We’re a full-service firm. I’ll try not to do too much of a pitch here. It’s nice. Because I used to be at Morrison & Foerster, which is a fantastic global law firm based out of San Francisco, but we always had a small office in Beijing and a small office in Shanghai. It didn’t have quite the full breadth that a local firm can do. Even though I love the guys at MoFo, it’s a unique, different setting to be at now.

Chris: A local firm, so this is Chinese native firm? Shanghai-based. The attorneys — are they mostly Chinese? Are they a combination of expats and Chinese?

Art: Mostly Chinese. Mostly Chinese. And then, we have a few of us foreigners who do manage projects. We really take care of the client relationships. Make sure the communications are smooth. We put ourselves in the shoes of those clients. That’s when I mentioned being in-house before really helps out to know what the general counsel is thinking.

Chris: And the clients — are they mostly domestic Chinese firms? Are they international firms wanting to access the China market? How does that break down in the types of services you give to different types of clients?

Art: They’re almost entirely international firms, America and European, doing business in China. There’s a variety. We have retail clients, we have industrial. My focus tends to be a little bit more on tech, from all those years that we mentioned before, in-house, and then at Morrison & Foerster before that.

Chris: Great. You’ve obviously worked in a number of different contexts. From an international firm, in-house, now a local firm. Through that time, what trends have you seen? I think this is a time where actually the formalization of corporate law in China has really made a lot of progress. Is that right?

Art: I think there’s a convergence going on. And it’s always been there. I think it’s gone the fastest on the commercial side. That’s to say, contracts law, incorporations of entities, cross-border licensing agreements, distribution agreements, M&A. The big trend I see is the convergence of the rules in China. Both on the regulatory side, as far as how industries are regulated, and then on the commercial side, how transactions happen. I see all the rules converging to international standards.

On the commercial side, I think that’s one of the trends that’s gone the fastest. That is to say, an M&A deal in China is very similar to an M&A deal outside of China. A licensing deal in China is very similar to one outside of China or cross-border. Of course, in commercial law of transactions, you can pick the governing law if it’s cross-border. There’s no politics really in commercial deals or anything like that. There’s a little bit more policy things that go on in regulatory. Like regulating different industries.

I think that’s why in commercial there’s that convergence. The fastest. Even in regulatory, as we’ll get into, probably data privacy. That’s following on the steps of GDPR. China does look to other regulatory regimes outside of China as models. I think that’s the big trend I’ve seen over the 15 years I’ve been here.

Chris: Really interesting. How about the population of internationally focused lawyers? Is that becoming more and more Chinese then, as things converge? And so, less of the expat lawyer?

Art: Yes. Us expat lawyers are certainly a dying breed here. That’s for sure. I remember when I was at Morrison & Foerster. That was late 2000s. It’s a bit of an exaggeration to say you could say, “你好 nǐ hǎo,” and graduate from a good law school, have a year or two of experience in a big city in the U.S., and come here and get whatever job you want. But it was definitely easier back then. You could see, over the few years, and then passed through the financial crisis of 2008, that started to change.

The story is…I remember we were doing agreements for a major sports organization and their business in China. The associate that was working underneath me at the time, he was Chinese. He’d never lived in the U.S., never studied in the U.S. I said, “Wang Yan, why don’t you try and take the first cut at these agreements? Let’s just see.” And the partner is like, “Let’s give him a chance. See what he can do.”

He drafted perfect documents almost. I just said, “Wang Yan, you just made me obsolete.” But that’s where you could see the writing on the wall. Chinese lawyers were, especially the ones that were going abroad, getting their degrees in the U.S. First, the master’s. And then, as more and more started getting JDs in the U.S. and coming back to China. They’re Chinese and they can draft very well.

Now, one thing we do have an advantage as international lawyers here is that…Like I mentioned on the communication side and on the cultural, so many of these things are just as much about cultural translation as they are about translating. Interpreting the actual rules or figuring out what rule. It’s interpretation. It’s explaining it in a context of rules that the U.S. client is familiar with in the U.S., and helping them compare it to that to help them wrap their head around it. That’s where the value still is for folks like me.

Chris: It makes sense. It’s a bridge to connect those two different systems. How about the legal education infrastructure in China then? You mentioned particularly folks that have a JD or maybe an LLM or something. They are definitely in demand. All the big schools like Peking University have a law school. How is the training there, as far as a route into international law?

Art: Those are definitely the best universities. The legal training there is excellent. I’m sure, in a lot of ways, it’s just as good substantively as any universities around the world. I will say one thing. Going through three years of a JD in the U.S. When I went through it … A lot of lawyers go through this, law students go through this and just think, “This is such a waste of time.”

You learn all the real core substance in the first year. The second year, you can start to take a few classes that you might find interesting. By the third year, you’re just like, “Get me the hell out of here.” You’re already ready to go in a lot of ways and just take the bar exam. But I really, after all these years, appreciate the teaching style of law school. Because it’s the Socratic method and it teaches the case method of learning.

You actually cram for the bar exam with these BARBRI classes. Paid classes where you actually learn what you were supposed to learn all that time. But the theory actually really helps you later on in life in your career. It teaches you how to think. And so, I never appreciated that at the time, but I definitely appreciate that now. The analytical skills that law school teaches you, it really does pay off. I think that’s probably still where there’s a difference between American law schools, for example, with that three-year JD program, and what you might get as an undergraduate here at Beida.

Chris: Got it. Because their law degree is an undergraduate degree.

Art: Well, you can get a master’s as well, but you can take the bar exam after an undergraduate here.

Chris: How about the different types of industries that you’re working with? We touched a little bit on tech. Is there others like financial services, healthcare … What are some of the international industries that are really represented among your clients?

Art: When I was at Morrison & Foerster, that was the time when a lot of big American technology companies were coming over. We worked for Dell, Apple, and UPS and some other major conglomerate companies. Then, when I went in-house to Cadence, I started to focus more and more on software. Because Cadence is an electronic design automation software company. It’s the software that you use to … It’s like computer-aided design software to design semiconductor chips.

After that experience of six years as an AsiaPac general counsel, I became a software guy as my core legal technical experience. And then, what I’ve noticed in the last few years, my clients more and more fall in this area, is software as a service. SAS. Cloud-based companies. Those companies … There’s definitely a slowdown in a lot of sectors in foreign investment here in China. But for companies which are asset-light software companies operating over a cloud, there’s not been any slowdown at all.

My clients are increasingly those clients. Enterprise software companies. China software companies are great at B2C, consumer applications, and so forth. Tencent, Alibaba, and the like. There’s still a lack of, in the ecosystem here, is these niche enterprise software companies that do a very specific thing. Managing a certain kind of data, like agricultural data. Or managing cybersecurity or something like that. Or supply chain management. We see these boring companies that no one’s ever heard of running purely on the cloud, coming over to China still, and not slowing down at all.

Chris: Interesting. Mentioning the cloud really makes me think about some of the data privacy regulations that have been in the news a lot recently. I would love to discuss those a little bit. You mentioned that they’re becoming more international. Maybe more like GDPR.

I recently interviewed some folks who had done a report on data privacy for the U.S.-China Business Council. There was this really evocative phrase in there, “In China, for China, data islands,” they described. Because of the portability of data. If you’re collecting data on China, they want it to stay in China, and not actually be able to move around to other data centers or other areas of the cloud. Could you talk a little bit about these new data regulations and how they’re affecting the clients that you work with?

Art: Sure. Absolutely. It’s a fascinating topic. And it’s the biggest topic over the last year. For sure. There is a lot of moving parts. The big thing that does stick out in people’s mind is that local storage requirement. Is it really a hard requirement? If you read the rules, it’s not a hard requirement. But when you get into the weeds a bit, some of the practical difficulties of complying with all the other requirements of the data privacy rules that came out last year…For example, you need to be able to correct the data.

If a user requests it, you need to be able to find it then. You need to be able to filter data, which is national security related or not national security related. Whether it’s called important data or not, which is not a well-defined term in the law. Or you need to potentially go under security review, if you’re exporting data. These things, no one really knows yet how it’s going to be enforced. People are naturally taking a cautious approach at first to keep the data here, if it’s easy enough to do.

Now, there’s some companies which have their analytical software or their algorithms running at headquarters in their big IT infrastructure. For some people, they’re still going to want to get the data out. Maybe they have to anonymize it or whatnot. That’s a whole other way people are trying to think about this. How do I still get valuable data out, that I can use at a macro analytical level, but maybe strip out some of the personal information that’s problematic?

Chris: Got it. That makes a lot of sense. That works under the provisions of the law? If it’s anonymized, that can still be used outside of China?

Art: Generally, yes. There’s personal information, which is really about the Personal Information Protection Law, which came out in November. If you’re anonymizing it, you’re basically there. You’re keeping a local copy there. You can fix it, again, if the user requests that you make corrections or take it off. That’s a win-win, where a local team can still have the information managed, and then maybe the headquarters can have the anonymized data that they’re just looking for.

Then, you’ve got the non-personal information, which is not usually an issue, unless it starts to get into these national security concerns. Critical information, infrastructure data that could touch on financial macro data, energy. These kinds of things which are on the periphery of national security or macroeconomic policy. Then, you have to evaluate it. Is this data which I need to keep here or cannot easily export because it has national security implications?

Chris: It’s interesting. I think when things are still in a little bit of an uncertain environment, companies are really being very cautious. I’m not sure if this exactly connects into these regulations, but I know that there’s been things in the press about … Actually, data issue was one of the reason why the Didi IPO was potentially problematic. Tesla has been in the news about having to have its data reside in China. That, to me, data of cars driving around …

Art: Location data.

Chris: That doesn’t seem to me like it should be national security, but people are still being a little bit conservative on that. Or am I seeing it the wrong way?

Art: Well, that’s locational data. Potentially. You’re talking about where people are going, which if you think about it, very definitely could be useful information to some people.

Chris: Right.

Art: But also, I think an aggregate … You’re getting into infrastructure usage, because those are almost infrastructure tools in and of themselves. Especially, if we’re talking about Didi. Didi is also about the personal information there on location and other things. I think also, Didi was just a bit cavalier about how they went about full speed ahead and not paying enough deference to the regulators. That’s usually a recipe for disaster.

Chris: Speaking of Didi and companies from China going public. There’s a lot of discussion about the VIE structure, Variable Interest Entity. Because some of the companies going public…Maybe all of them, I’m not sure, actually are structured in that way. It’s a structure that’s been around, I learned from your newsletters, a very long time. 20 years. So this is not a new thing, certainly. Although, certainly in the press a lot more. Can you say a little bit about what that structure is and how it actually helps companies from China go public or operate internationally?

Art: Sure. I’ll try and be concise, but a lot to unpack there. For most companies, it starts with the license that you need as an internet business. Internet business broadly defined as eCommerce. Anything that’s a value-added telecom service. Something that is using the internet where the business is primarily running on the internet. And that could be mobile internet as well. These things are regulated and need a value-added telecom services license. One of the most common ones is the ICP license, Internet Content Provider license. A lot of these tech companies that list on NASDAQ need an ICP license to run their core business.

These businesses, if they want to raise money from foreign investors and eventually list on NASDAQ or wherever…They are restricted. To get this license, you cannot be foreign invested. You have to be a local company. Therefore, they created 20 years ago…You’re right. They created this elaborate structure, where the offshore company that’s going to go IPO doesn’t actually own the operating company that holds this key license in China.

But it’s connected through this roundabout way with contracts that lock up the shareholders, which is often the founder of the company. It locks up the revenue, the after-tax profit of the business. Through these contracts, the auditors will sign off that this is like a group company. Even though it’s not an actual subsidiary, it’s so locked up, it’s as if it is a subsidiary of the group.

Leave it to some lawyers 20 years ago to bang heads with investment bankers and accountants to figure something out so ingenious like this. I can appreciate it. For sure. But everyone else outside of China is like, “What is this thing? It doesn’t make any sense.” And it’s just this peculiarity of the fact that internet businesses are regulated, need a specific license, and that license cannot be held by a company that takes foreign investment.

Chris: And then, so the shareholders on NASDAQ or New York Stock Exchange, they actually basically own shares in this entity that has contracts for the revenue of the underlying asset.

Art: Yeah. It’s funny. Because once in a while, you get one of these analysts point out that, “Hey. Look. Right here in the risk factor. Hey. They don’t actually own the company that has all the value.” And I just kind of laugh at that. Of course, everybody out here laughs at that. Because we’re like, “Duh.”

That’s the age-old question. We all go back and forth about that. Will they ever really crack down on this VIE? It is a bit of like a guillotine thing. It’s a tentative relationship. It’s never really been enforced, those kinds of contracts. There are cases. The most infamous one is Alipay. The Jack Ma (马云 Mǎ Yún), SoftBank, Yahoo falling out.

That was over the fact that Jack Ma was saying that these VIE contracts are not really allowed for this industry anymore. There’s always that threat. Or a founder goes rogue. Says, “I don’t know ways to honor these contracts and good luck enforcing them.” But in the vast majority of cases, especially where you have the founder sitting at that local operating company as a PRC national and at the offshore structure, he’s got aligned incentives to make everything work. Most companies at list on NASDAQ are in that situation. It is still a relatively safe structure. All things considered.

Chris: You gave the example. Maybe it might be interesting to talk about a little bit of Meituan-Dianping, which I thought was helpful in really elaborating how this works.

Art: Yes. The founder of Meituan-Dianping, he actually…You can look right there. Wáng Xìng 王兴 is listed there as one of the two primary shareholders of the operating company. And then, he’s also a 20% or 30% owner at the offshore company that’s going public. He’s not going to do anything foolish down here to rock the boat. He’s not going to take the company and run away with his buddy. Because he’s got so much incentive to cash out, maybe slowly over time, at the list code level.

Those are the perfect situations where the incentives are aligned. Foreign companies … We always have to present this as an option. Even though we don’t necessarily endorse it too much. If you’re more of a strategic investor, you’re a multinational company, maybe you know you have to get this license. You look to what these Chinese companies have done and say, “Well, can I do a structure like that? A VIE structure?”

There it’s a bit different. Because you’re really going to struggle with the aligning of incentives like Wang Xing and Meituan-Dianping had. You’re not going to have that natural guy, who’s going to have so much equity up here and so much equity down here that it all works.

Chris: I can imagine, for these Chinese nationals, this is a great way to get liquid currency in some ways. If they are going to sell over time. There’s so much difficulty transferring money in and out of China. Maybe not into China, but traveling out of China. You can see how the incentives really align, because it gives them this big pot of money outside of China.

Art: There’s probably some of that. I think the primary thing is … When these tech companies were going public, starting in the 2000s, they needed to go public in a place that was receptive to companies that weren’t profitable yet. Where do you go? NASDAQ.

Which was where all of the dot-com companies went a decade before. The capital markets weren’t mature enough here and not flexible enough. I think there was still the requirement you needed to be profitable for three years. None of these companies were. And then, Hong Kong, similarly. The US has a big pool. Of course, the capital markets are bigger.

And then, the venture capital ecosystem was slow to develop here. You had the Sequoia and the Kleiner Perkins coming over here in the 2000s. There was no local VC industry. Those guys are going to want you to structure for an IPO in NASDAQ. That’s the ducks all aligned to have this elaborate structure.

Chris: Makes sense. I’d like to hear a little bit about the VC infrastructure that you just mentioned. I know that’s another topic that you’ve written a bit about. Can you say, particularly in regards to the law, how the VC infrastructure has developed?

Art: Sure. I think in the beginning…Because 20 years ago or more, there was no experience here of venture capital. There was no starting point. The starting point became a lot of folks from Silicon Valley coming over here. That’s when I started. Morrison & Foerster has a big venture capital practice. I was immediately thrown onto those kinds of deals when I came over here as a young associate. That time, the term sheets, the basic terms that would go into these deals were definitely borrowed from Silicon Valley templates.

That was a pretty easy handover. But one thing that definitely was different, was there were still some of the old draconian provisions from back in the day in Silicon Valley, which were already on their way out. We definitely don’t have the time to explain all this, but there’s this provision called full ratchet, which is a penalty term for when there’s a down round in a venture capital financing. And it’s so draconian. You don’t even see it anymore in the US, as far as I know.

Of course, I’ve been here 15 years, so maybe I don’t know anymore about the US. But you still see these outliers like that. Someone from Silicon Valley would be scratching their head like, “Wow. You still can get that in a term sheet?” That’s also going back to this idea of convergence. I think that’s also on its way out here too. People realize like, “Come on. This is just not fair to founders and so forth.” I think founders have become incredibly sophisticated here. Like their cousins in Silicon Valley. And so, I think a lot of those kind of shenanigans no longer apply.

Chris: That makes sense. I don’t follow the VC industry particularly closely. But I do know, for instance, Sequoia is the famous example. They’ve grown in China actually more than anywhere else.

Art: They’re the gold standard.

Chris: And Neil Shen is one of their top people globally. This has been super interesting. I don’t want to take up too much of your time. I just have one final question. Looking forward in the next couple years, as you’re advising foreign companies entering China, what are the few pieces advice you’d say, “Okay. Here are the things that should be top of mind as you enter China from a legal perspective.”

Art: I think a lot of people get hung up on the fact that it’s complicated. That’s where we come in. That’s our role is to explain, “It’s complicated, but in many cases it’s doable.” Where there’s a will, there’s a way. You can look at the data regulations. You can look at these things like VIE structures. You can look at how long it takes to set up a company here versus the U.S. All these things are improving.

At the same time, they’re never as bad as you hear about. The horror stories. I think that the thing, key thing to think about is, one, it’s complicated, but doable. Two, you don’t have to be perfect. Whereas, in the U.S., I think there’s a focus on very defined terms and regulations. You have so much legislative history and judicial decisions interpreting how things…There’s so much clarity. Here, that just doesn’t exist.

To be honest, that’s what makes the job fun too, is to try and fill in those gaps with the experience. You’re not going to find a regulation or an interpretation of it anywhere. You just have to know how it works on the ground. And so, that’s where we come in. What I always say is, “You need a story.” The regulators in industries which are more regulated, they’re not actively looking to shut businesses down. They’re not picking on foreign companies. They’re still very welcoming of foreign investment here, especially if it’s an industry that they’re trying to develop.

You just need to have an argument, if you’re ever challenged by the regulators. “This is what we’re trying to do. This is the structure we have. These are the rules that we looked at. This is our logic. And if you disagree with us, we’ll try and fix it.” They will give you a chance to fix it. I think the point is that it can seem overwhelming at first, but if you have patience and perseverance, you can make it through. Of course, there’s a big market here. There’s a reason why companies still come here after all of these headaches and after all of these trade wars and after all of these things going on.

Chris: Great. Well, that’s a good way to end. I know there are a lot of trade tensions between the West and China, but I’ve been hearing from all the businesses I talked to, there’s still lots of opportunity. And so, this is very consistent with that. Thanks so much for joining us today on China Corner Office, Art.

Art: Thanks, Chris, for having me. Really appreciate it.