Lawyers as Outlaws in Shanghai

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We have recently seen foreign accountants getting in trouble in China (Deloitte with their Kelon audit, and Ernst & Young with their bad loan counting). Now it is the turn of foreign lawyers.

ChinaLawBlog, posted about a crackdown on foreign law firms by the local authorities in Shanghai. (Updated here). They passed a copy of an official memorandum from the Shanghai Bar Association to China Confidential. The accusation is that foreign lawyers have been indulging in “illegal activities” in what is a highly regulated market.

China Confidential’s article reminds us that “Chinese representative offices of overseas law firms are prohibited from conducting any legal services concerning Chinese law”. The article goes on to list the permitted activities, as well as the illegal ones – which might come as a surprise to some, but are generally known in the market.

A senior Chinese lawyer at a major local firm agreed, in conversation with me today, that it is well-known in the industry (and government) that many foreign law firms operate outside their technical scope of business. Most do this by providing “consulting services”, but the line dividing “legal” and “consulting” work is rather grey. This grey area is not new in Chinese legal services. Pre-WTO, some very well-known foreign firms set up more than the officially-sanctioned, single office. They did this by having a formal representative office (e.g. in Beijing) and another consulting company (e.g. in Shanghai or Guangzhou).

The lawyer mentioned that his firm had been asked to sign a petition to have a crackdown on the offending foreign firms. His firm declined, but many others did sign. Some of the reasons for the action include the fact that small and medium-sized firms find it difficult to compete and be profitable in the face of foreign competition. Foreign companies can hire local associates, trained at local firms, and pay them 2 or 3 times their existing salaries. Partly on account of the high salaries, for locals and foreigners alike, it is thought that many foreign firms are not profitable in their China businesses – but that they can fund any loss through their international business.

As China Confidential also notes, the crackdown may be partly protectionist, but it follows in the wake of a crackdown on the media, as well as a general review of feelings towards foreign influence (“malicious foreign investment”). It may also reflect growing focus on the service sector (especially banks, accountants and lawyers) which has largely been ignored in favour of industry and trade in the past but which, with the advent of the “innovative economy”, is seen to be a critical part of the economy in the future. Another Chinese lawyer pointed out that the Ministry of Justice has been planning to tighten up regulations for legal services generally, and that it should not be assumed that enforcement will be as lax as it has been in the past. Foreign lawyers, beware!

While many businesses in China operate on the basis that it is “the rule of man, not the rule of law” that counts (i.e. officials have some flexibility in how they choose to interpret often loosely written regulations), it is pretty clear that law firms should not rely on this approach. This is doubly true if, as is suggested by an Interfax China report quoted on ChinaLawBlog:

    ”Potentially, all transactions that have taken place to date, including contracts, financing agreements and IPOs, that have used documents drafted by foreign law firms as their legal basis could be declared null and void by the government on the grounds that the firms lacked the authorization to issue such documents, said Dickinson.”

While that sounds like overkill to me, and Dickinson agrees this eventuality is “unlikely”, it certainly causes one to pause for thought.

I am only one of many who often highlights the need for due diligence (as well as cultural and commercial sensitivity) when doing business in China. Even when dealing with lawyers.

Note: A translation of the memo can be seen on ChinaLawBlog, here.

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One Response to “Lawyers as Outlaws in Shanghai”

  1. Archive » Wal-Mart Stonewalls on Unions| China Business Blog Says:

    […] d anti-monopoly law, promotion of “national champions” in the accounting sector, and a crackdown on foreign lawyers in Shanghai. I suspect a bit of a PR battle may also ensue. See ne […]

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