Business Terms for Establishing WFOE Arrangement

To have a WFOE in China, you should first and foremost possess a valid lease. Now, this, in Chinese context is easier said than done. Various business owners from outside China looking to do business in the country often ask Chinese business lawyers, “how is it possible to have a valid lease for WFOE when it does not even logically exist in the first place?” To be able to know about it, you should first know about what WFOE is.

What is WFOE?

A WFOE or Wholly Foreign-Owned Enterprise is a type of investment vehicle for mainland China-based business. Under this, a China-based business party can incorporate a foreign-owned business in the form of limited liability company. The characteristic feature of a WFOE is that it can take place without the presence of a Chinese investor unlike the majority of other investment vehicles.

WFOE companies may be funded by foreign investors and also organized by foreign nationals. This provides better control over the business venture in China which also prevents a large number of issues resulting from domestic joint venture business dealings. This includes breach in contract and leakage of information and profits not being optimized. Under WFOE, the foreign firm chooses to manufacture products in China and sell it to the world. In such a circumstance, the imported products can be duty-free inside China. There is an additional advantage of such an arrangement, that is, claiming back VAT on the China produced component parts upon export. WFOEs have the right to distribute their products in China through retail and wholesale channels.

There are some more advantages to WFOEs:

  • Such companies can work on their global business strategy without any interference from the Chinese partners.

  • Provides an independent legal entity

  • Total management administration within PRC law limitations

  • The power to receive and remit RMB to the investment organization abroad.

  • More protection of patents, trademarks

  • Exemption from obtaining an import/export license for manufactured items

  • Stakeholder liability is limited to original investment

  • Comparatively easy to dissolve Equity joint venture

  • Entire control of human resource

There are some distinct disadvantages to WFOEs. For instance, business options are restricted in WFOE setup. Support from government will be limited and so also the movement curve will be steep within the Chinese market. Also, you will need to invest at least 15% of the investment money within a month of obtaining the business license. Please note, Chinese legislation is not the same everywhere and hence the differences will be applicable.

Now, coming back to the questions client ask China lawyers to know and understand the concept. They usually ask about what the document consists of. The lease document does not include any terms and conditions for dealing with lease to an identity preparing for WFOE. In fact, lease execution depends on a large extent to you providing a business license. Now, that is impossible because you cannot do so without WFOE existence.

The landlord can be convinced to cooperate with you regarding WFOE formation purposes. He should understand that the WFOE will be in the name of the WFOE shareholder instead of the landlord. Only after the formation is complete, the name will be transferred to that of the landlord. The landlord should permit the WFOE shareholder to use the land in anyway the entity wishes to. He/she must cooperate with the shareholder. The terms and conditions should also comply with the laws and regulation of the concerned state. This includes that the landlord will pay the taxes and give them to the tenant. Without knowing the identity of the WFOE shareholder, no such arrangement can be made.

WFOE can be entered into by satisfying all the requirements mentioned above in the write up. In case, any of these remains unfulfilled, you will not be eligible for WFOE.

Share with friends:

Pitfalls of Chinese Manufacturing Binding Agreements

An effective Chinese manufacturing agreement must address various issues out of which the most vital part is the one constituting terms for purchase of the manufactured item. Three things are critical to a business establishment, quantity, price and date of delivery. Since these are the key factors, these must be addressed right at the beginning of preparing a contract. A Chinese lawyer is required to draft a contract by clearing explaining these terms right at the beginning.

Incorporating these fundamental terms right at the onset can be done in 2 ways. The ways are:

  1. The manufacturing contract drawn for purchase of goods is a binding one for a particular quantity of product to be delivered within a stipulated time frame and a fixed price. The outstation purchaser has an obligation to purchase while the manufacturer is compelled to sell. Failure in any of these will be considered as a breach of agreement. A letter of credit is often attached to this kind of agreement.
  2. A contract stating the purchase of goods is formed only after the foreign purchaser submits the purchase order which is also accepted by the Chinese manufacturer for which the terms and conditions are laid earlier. This contract is however not formed when the foreign buyer does not provide a purchase order and the Chinese manufacturer does not have anything to accept it. In case there is no submission of order or there is a rejection of order these are not considered as breach of contract. This type of agreement comes without a letter of credit.

The first option is opted by the multinationals ordering large quantities of products from Chinese firms. It comes with 2 advantages:

  • The risk of price fluctuation is absent because it is locked for a particular period. However, in case of any cost changes, both the parties bear it equally.
  • The delivery date for product is fixed and hence the buyer can plan for any kind of seasonal variation. The only risk involved in this is that the buyer might get stuck with a full inventory of products.

The second option is more viable for start-ups or for companies launching new items with an undetermined sales market. It allows the foreign buyers to test the waters before launching the new produce in the new market. Moreover, the buyers do not face any loss regarding failure of products and being stuck with unsold inventory.

The basic disadvantage integral to this arrangement is that the Chinese factory can deny any business terms anytime because there is no documentation of contracts. In fact, this is a tool used by Chinese manufacturers to raise price by rejecting the purchase order. They also reject if they are unable to provide required quantity and also unable to meet the delivery deadline. The toughest part is that the buyer really does not have much choice apart from accepting the rejection from the Chinese counterpart.

In a nutshell the situation is not in favour of the foreign buyer because the Chinese company can negotiate any price for producing the products. It is also not possible to force them to deliver products on time. Just imagine the kind of trouble a start-up will land into with a single new product. A start-up receives sustainable orders after lot of effort and it requires fulfilling the deadline in terms of time and delivery. The start-up is obligated to perform because the US and EU buyers stress on binding contract.

Now, the real trouble begins when the start-up submits their purchase order and the Chinese manufacturer rejects it asking for a price hike. The start-up can be subjected to a lawsuit in its home land due to failure of on time delivery of products and it is considered as a breach of contract. It suffers from bad reputation and also from financial loss and can only recover if it has financial backing; sad news is that, these companies generally do not recover from this blow. They realize late that they were working under the illusion of a binding contract with the Chinese manufacturer come product supplier.

China lawyers receive calls all the time from EU or USA retailers who get trapped into this “no business terms”. However, there is no solution expect from being careful the next time. The ‘business terms’ issue must be addressed properly for every manufacturing contract because it is confined to this only but spreads to other issues as well. For instance, the Chinese manufacturer you are working with is supposed to provide a certain type of packaging along with the product. However, it decides at the last moment not to do it but the price is included in it. Under the second option, the manufacturer will reject the purchase order expecting to negotiate which means that the original condition was illusory because the manufacturer has no obligation to perform.

It is only after the tide has passed that you discover who has been swimming naked. This adage is true for companies from EU and US working with Chinese manufacturers. It is often late when business owners realize that their Chinese manufacturers have left them with no clothes. The moment you decide to work with Chinese manufacturers, you also need to decide which option will be applicable to the contract that incorporates those terms that legalize your decision. Otherwise operating under an illusion will lead you towards unpleasant consequences.

Share with friends: