The risks of denunciation, inspections and disputes in China

Businesses in China often have to navigate strict administrative procedures, particularly in the case of whistleblowing or commercial disputes. The combined impact of sectoral opening reforms and increased 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 foreign owned companies (WFOE) and joint ventures (JV) also face risky situations in a sometimes unpredictable environment. While foreign investors are known to be very sensitive to the criminal liability of their executives and directors, here are some examples of blockages and disputes they commonly encounter in China.

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

According to the "Measures for the Management of the Abnormal Status List of Enterprises" published since 2014, a company will be blacklisted in "abnormal status" in the following situations:

• The company has failed to submit its annual audit report on time. This is governed by Article 8 of the "Provisional Regulations on the Publication of Company Information" (企业信息公示暂行条例). This is one of the most common reasons for irregularities.
  
  
• The company's legal registration address as recorded in its business licence is not the same as its actual business address. With a few very limited exceptions in certain special zones, a company registered in China must have its registered address at its principal place of business. The risks associated with such inspections have increased significantly in recent years.
  
  
• The company has not officially published the information required by Article 10 of the "Provisional Regulations on the Publication of Company Information". This article requires each company to publish 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, dates of payment, type of contribution)
    
  • Change of investors, change of shareholders, acquisition of shareholdings
  • Any information relating to a domestic branch or sales office
    
  • Administrative sanctions
    
  • Intellectual property information
    
  • Other changes in the company's structure or extension of administrative authorisations.

• The company will be deemed to have concealed the truth by providing false information on any or all of the above. This is a serious offence in China and is punishable by law.
  

The authorities carry out regular inspections of offices and workplaces. Several authorities are involved. The most important are the State Administration for Market Regulation (SAMR), the Tax Bureau (SAT) and the Labor and Social Affairs Bureau.

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The SAMR or the Chinese customs carry out some checks by sampling products. This administrative supervision is the strictest and the most severe sanction reserved for sectors related to the safety of goods and people. It primarily affects companies involved in the import, distribution or manufacture of 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.

Once 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, may be directly affected by prohibitions or restrictions. At this stage, any request to change the structure of the company (shareholding, purpose of the company, etc.) will be rejected. Abnormal status", which also means "irregular", can have a major impact on day-to-day operations.

The social credit data of companies are public and distributed nationwide. It can be consulted on the public website "National Platform for the Exchange of Credit Information". For each company, you'll find a list of

• Administrative sanctions (fines, penalties and reasons)
• Reports of of irregularities (in declarations, for example)
• Mentions of any illegal behavior (bad records).

In the eyes of third parties, this has a direct impact on the company's image and, potentially, its value. To remove its name from a blacklist, a company must make commitments and take corrective action.

b. Violation of China's Advertising Law

Under the revised 2021 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 restrictions or prohibitions. They may not be used on products or public communication documents. This includes a company's website and Wechat Pro account, its brochures distributed in China and any other form of local public.

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Examples of forbidden words	Superlatives and words referring to "national", terms with the meaning of "best".
Examples of Words to avoid	To limit risk, we recommend that you avoid using dithyrambic words or words with an absolute meaning that cannot be supported by objective evidence. Examples include: unique, first, minimum, maximum, world leader, champion, top 1, 100%, absolute, pure.

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Example for dietary or health foor supplements and cosmetics:

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

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

• Food supplements are not medicinal products. If they help to optimise the functions of the human body, they cannot be used and presented as an adjuvant therapy.

This excerpt from a Chinese regulation states that the fine for violating the Advertising Law ranges from CNY 200,000 to CNY 1 million. The final amount is also subject to negotiation and will be determined by officials according to the specifics of each case. The fine is accompanied by a notice of bad reputation ("bad administrative record"). This information is made public and has a direct impact on the reputation and credit of the business concerned.

Case study: a cake (pastry) shop in Shanghai After using superlatives and the term "unique" in its customer menu, the company was notified by the authorities that it had violated the Advertising Law. The practice was classified as misleading advertising and a fine was imposed.

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c. Disputes with Chinese customs

A customs declaration is required for all imported and exported goods. It must be filed electronically through a customs broker.

When completing 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 payable, as well as checking compliance with Chinese standards, are at stake.
  
  
• For exports from China, this may result in a refund of part of the VAT paid.

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

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Client case analysis: a China-based importer of equipment for the disabled   Based on a whistleblower report from a competitor, the local customs office issued a non-compliance notice to this company. It stated that their imported products should be classified and treated as equipment for all types of people, not just the disabled. According to the current customs nomenclature, the local HS code and duty rates for products specifically designed for the disabled are different (lower) than those for equipment used 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 contain any texts specifically applicable to equipment for the disabled. As a result, the importer has never been able to validate the specific "disability" vocation of its products on Chinese soil. Local customs do not recognise test reports or certificates of conformity issued by foreign laboratories that are valid in other markets. At best, 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 two years of negotiations. These were conducted first with the provincial authorities and then with the central authorities in Beijing before a satisfactory official solution was found. Find out more on our page dedicated to Customs Administration (GACC) in China.

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

In China, commercial disputes often arise from contractual disputes. They are common 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 engage a Chinese lawyer and, if necessary, a negotiator.

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Client experience: a foreign-owned company specializing in product design and advertising. Its client (a local joint venture) held it responsible for failing to deliver products on time. This situation jeopardised its own commercial commitments. Involved in a legal dispute and ordered to repay more than 4 million CNY plus penalties, the commercial and financial consequences of this decision led the condemned company to consider shutting down its operations in China. From a risk perspective, this simply meant dissolving the company and terminating its licences in China.

Disgruntled employees or suppliers with whom a dispute has not been satisfactorily resolved may not hesitate to bring to the attention of the authorities situations within a company that they know are dubious or illegal.

In addition, a jealous competitor may be tempted to use whistleblowing as a means of demonstrating his or her ability to cause trouble for non-commercial reasons. Of course, Chinese companies are used to managing and practising 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 seen many complaints and denunciations from employees or competitors. Dedicated telephone complaint numbers and special 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 hired by a competitor in the industry. The case is still pending at the time of writing.

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Customer case study: a foreign-owned coffee bar in Shanghai Although the business had all the necessary qualifications and licences, it was located close to a residential area. As a result of increasing complaints from neighbours (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 complaints from the neighbourhood, which they deal with diligently. Depending on the situation, these complaints may or may not be justified. They often concern restaurants and bars. In the case of restaurants, for example, it's the smoke extraction system that doesn't comply with the regulations. In the case of bars, the complaints are often about noise.

Chinese regulations are intended to apply uniformly to all companies registered in China. However, in practice, inspections, audits, and their outcomes can have varying consequences depending on whether the target is a foreign-invested enterprise, a private Chinese company, or a state-owned enterprise.

In cases of whistleblowing or denunciation, local actors often leverage their influence and networks to resolve disputes more efficiently with the relevant authorities.

Before initiating legal proceedings, conducting a thorough investigation is essential to assess the likelihood of success and explore alternative solutions, such as direct negotiation with the opposing party. In commercial disputes, it is crucial to understand the available options for arbitration and litigation to choose the most suitable approach for resolving conflicts. Mediation and conciliation can be prioritized to avoid lengthy and costly procedures, while arbitration remains a popular choice for addressing complex commercial disputes.

The following examples highlight specific cases where we have provided assistance:

• Risk analysis in China: Supporting company executives in anticipating potential risks and implementing tailored standard operating procedures (SOPs), such as those for handling factory accidents or incidents involving end users.
  
  
• Dispute management and negotiations with authorities: Assisting companies in managing non-compliance issues identified during inspections or denunciations to mitigate administrative or legal consequences.
  
• Resolution of disputes arising from denunciations: Guiding businesses through conflict resolution to achieve pragmatic and effective solutions.

Such interventions help companies better navigate regulatory challenges and secure their operations in a complex and evolving environment.

[ contact us about business disputes in China]