Business set-up and consulting in China

The risks of denunciation, controls and disputes in China

By C.i. Process (Shanghai)
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inspection and dispute resolution in China

Accompanying numerous companies as they set up and expand in China, we testify to a number of spectacular success stories. We also observe the consequences of whistleblowing and disputes impact others, damaging their reputation and their business. These consequences sometimes lead to bankruptcy and closure. Often less well-informed and less prepared than domestic companies, here is a presentation of some of the fairly common risks and disputes faced by subsidiaries of foreign companies in China.

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corporate risks for dispute in China
 
  Publication updated on January 2, 2024      
 
Home > regulations and news > How to manage the risk of denunciation, controls and disputes in China
 


1. Administrative disputes with Chinese authorities and administrations

The combined impact of sectoral opening-up reforms and intensifying competition in all sectors means that foreign companies operating in China are increasingly involved in civil and criminal litigation. Continued business opportunities and the ongoing revision of investment laws and regulations are leading to a growing number of Western companies setting up operations in China.

LLC companies foreign owned (WFOE) and joint ventures (JV) also encounter risky situations in a sometimes unpredictable environment. While foreign investors are reputed very sensitive to criminal liability of their executives and directors, here are a few examples of blockings and disputes they commonly encounter in China.

 

a. Chinese authorities classify a company in "abnormal" status

According to the "Measures for the Management of the Abnormal Status List of Enterprises" published since 2014, an enterprise is blacklisted to "abnormal status" in the following situations:

  • The company has not submitted its annual audit report on time. This is regulated under the terms of Article 8 of the "Provisional Regulations on the Publication of Corporate Information" (企业信息公示暂行条例). This is one of the most frequent reasons for irregularity.

  • The company's legal registration address, as recorded in its operating license, is not the same as the actual operating address. Apart from a few very limited exceptions in certain special zones, a company registered in China must have its registration address at the main address of its activities. In recent years, the risks associated with such controls have become much greater.

  • The company has not officially published the information required under Article 10 of the "Provisional Regulations on the Publication of Company Information". According to this article, every company must declare the following information on the website of the "Company Information and Credit Publication System". This includes information on the following subjects :

    • registered and paid-up capital (amount, payment dates, nature of contribution)
    • Modification of investors, change of shareholders, acquisition of holdings
    • Administrative sanctions
    • Intellectual property information
    • Other changes in structuring or extension of administrative approvals.
  • The company is deemed to be concealing the truth by submitting false information on all or part of the above-mentioned items. In China, this is a serious offence which carries penalties.


The authorities conduct periodic inspections of office & workplaces. Several authorities are involved. First and foremost are the State Administration for Market Regulation (SAMR), the Tax Bureau (SAT) and the Labor and Social Affairs Bureau.

 

SAMR, China's market supervisory authority


The SAMR or the Chinese customs conduct some checks by sampling products. This administrative supervision is the strictest and the most severe sanctions reserved for sectors linked to the safety of goods and people. It primarily affects companies involved in importing, distributing or manufacturing food products, or drugs, pharmaceuticals and medical devices in China. Other sectors affected include construction quality, industrial and environmental safety, to name but a few.

As soon as a company is registered as irregular (recorded as abnormal status), this information becomes public. It affects the company's social credit, which is visible to all customers, competitors, business partners and banks. As a result, loans, guarantees or insurance already granted, as well as the status of bank accounts, can be directly affected by prohibitions or restrictions. At this stage, any request to modify the company's structure (shareholding, corporate purpose, etc.) is refused. Abnormal status", also meaning "irregular", can have a major impact on day-to-day operations.

Corporate social credit data is public and distributed nationwide. They can be consulted on the public website "national platform for sharing credit information". For any given company, you'll find a list of :

  • administrative sanctions (fines, penalties and reasons)
  • notifications of irregularities (in declarations, for example)
  • mentions of any illicit behavior (bad records).

In the eyes of third parties, this directly affects the company's image and, potentially, its value. To remove its name from a blacklist, a company must make commitments and take corrective action. On this subject, see our article on corporate social credit in China.


b. Violation of China's Advertising Law


Under the 2021 revised version of China's Advertising Law (中华人民共和国广告法2021修正), certain sensitive words are subject to limitations or bans. They may not be used either on products or on public communicating documents. This includes a company's website and Wechat Pro account, its brochures distributed in China and any other form of local public communication.

 

Examples of
forbidden words

Superlatives and words referring to "national", terms containing the meaning of "best".

Examples of
words to avoid

In order to limit the risks, we recommend avoiding the use of dithyrambic terms or terms with an absolute meaning that cannot be attested by objective evidence. Examples include: unique, first, minimum, maximum, world leader, champion, top 1, 100%, absolutely, purely.

 

Example for dietary or health foor supplements and cosmetic products:

  • It is forbidden to use terms that imply a therapeutic effect. These products have no recognized therapeutic use.

  • Advertising that exaggerates the product's effect is prohibited (grounds for misleading advertising).

  • Food supplements do not qualify as medicines. If they help to optimize the functions of the human body, they cannot be used and presented as means of auxiliary therapy.


corporate offences and fines in China  

This extract from a Chinese regulation stipulates that the amount of the fine for non-compliance with the Advertising Law ranges from CNY 200,000 to 1 million. Also subject to negotiation, the final amount is decided by officers according to each case particularity.

The fine comes with a notice of bad reputation ("bad administrtive record").

This information becomes public and therefore directly affects the reputation and credit of the company concerned.




Case: a pastry shop in Shanghai

Having resorted to the use of superlatives and the mention "unique" in its customer menu, the company was notified by the authorities of violating the Advertising Law. The practice was qualified and fined as misleading advertising.

 

c. Disputes with Chinese customs

Filing a customs declaration is compulsory for all imported and exported goods. It must be filed electronically by a customs broker.

When filling an import or export declaration, the commercial description of each item and its Chinese HS code must be entered.

  • For imports, the value of customs duties and VAT to be paid, in addition to the compliance check for China standards, are at stake.

  • In the case of exports from China, this may involve the return of a proportion of the input VAT paid.

What are the risks and what should be done in the event of a dispute between a company and a China customs bureau over the classification of customs codes (HS codes)?

 


Case study: a china based importer of equipment for the disabled

 

On the basis of a whistleblower's report from a competitor, local customs issued a non-compliance notification to this company. It specified that its imported products had to be classified and treated as equipment usable by all types of people, not just the disabled.

The current customs nomenclature indicates that the local HS code and duty rates for products specifically for the disabled differ (downwards) from those for equipment usable by the general public.

Customs required the importer to pay the duty differential on all past imports. In addition, the company was liable for fines and penalties calculated retroactively to the date and value of each past import.

The company has duly completed certifications in many of the countries where its subsidiaries or agents import these products. However, the Chinese standards system does not have any texts specifically applicable to equipment for the disabled. As a result, the importer had never been able to validate, on Chinese soil, the specific "disabled" vocation of its products.

Local customs do not recognize test reports or certificates of conformity issued by foreign laboratories that are valid in other markets. At most, certified translations of these certificates have an indicative value that does not influence the conclusions of inspection and control services. For the authorities, the symbolic stakes involved in this example, as well as the substantial amounts involved, required almost 2 years of negotiation. They were conducted first with provincial and then central authorities in Beijing, before finding a happy official resolution.

Find out more on our page dedicated to customs administration (GACC) in China.


 


2. Business dispute with a supplier or customer in China


As the economy develops, an increasing number of disputes arise in connection with commercial activities, property law and the protection of intellectual property rights (patents, trademarks, logos).

In China, commercial disputes are often due to contractual disputes. They are frequent in the sale and purchase of products, particularly in the case of late delivery or non-conforming goods. In the event of a dispute, it is advisable to seek the services of a Chinese lawyer and, if necessary, a negotiator.


Case study: a foreign-owned company specializing in product design and advertising.

Its customer (a local joint venture) held it responsible for failing to deliver products on time. This situation jeopardized its own commercial commitments. Embroiled in a lawsuit and ordered to repay more than CNY 4 million + penalties, the commercial and financial consequences of this decision led the condemned company to consider stopping its activities in China. In terms of risk, this simply meant dissolving the company and terminating its licenses in China..



 

3. Whistleblowing by an employee or a competitor


Unhappy employees or suppliers with whom a satisfactory resolution to a dispute has not been found may not hesitate to bring to the attention of the authorities situations they know to be dubious or illegal within a company.

In addition, an envious competitor may be tempted to use whistleblowing as a means of demonstrating his or her ability to cause a nuisance on non-commercial ground. Naturally, Chinese companies are used to managing and practicing this among themselves, on a large scale.

As part of our risk analysis, we would point out that denunciation is encouraged and paid for by the Chinese authorities. In recent years, we have observed many complaints and denunciations made by employees or competitors. Dedicated telephone complaint numbers and specific mobile applications have even seen the light of day.

 

Whistleblowing situation: a foreign-owned company engaged in import trading

One of its employees took legal action because of the discrepancy between the actual products and the technical specifications of the products presented in its brochure. The employee had been illegally used and commissioned by a competitor in the sector.

The lawsuit is still pending at the time of writing.


 

 

4. Handling nuisance complaints from neighbors

 

Case study: a foreign owned coffee bar in Shanghai

Although the establishment had all the required qualifications & licenses, it was located near a residential area. With rising neighborhood discontent (noise), the authorities ordered the café to close or change address.

This illustrates that, even if the establishment complies with laws and regulations, the authorities sometimes receive neighborhood complaints, which they deal with diligently. Depending on the situation, these complaints may or may not be well-founded. They frequently concern restaurants and bars. In the case of restaurants, for example, it's the smoke evacuation system that doesn't comply with regulations. For bars, the grounds for complaint are often noise pollution.




5. To remember about managing business disputes in China

Chinese regulations are supposed to apply uniformly to all companies registered in China. The reality is that controls, inspections and their conclusions do not always have the same consequences when the targets are foreign-owned companies, private Chinese companies or state-owned companies.

Following a report or denunciation, the influence and networks of Chinese players with the authorities often enable them to resolve disputes more fluidly.

The examples cited in this article illustrate situations in which we have assisted customers:

  • assisting company managers in their risk analysis in China and anticipating situations that may arise (drafting procedures to be followed in the event of accidents in the factory, customer-user accidents, etc.)..

  • manage dispute situations and negotiate with Chinese authorities the consequences of non-compliance identified during inspections or denunciations.

  • Help resolve disputes following whistle-blowing.

 

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