The China Company within YOUR Company

China lawyersMany years ago, a very good client of mine in the international food brokerage business learned that one of its employees had set up a rival company and was using my client’s resources to generate business for that rival company. To grossly oversimplify, whenever this employee would find a particularly good deal on product, it would buy and then resell that product on behalf of its own company, not on its employer’s behalf. I lead with this to emphasize that this sort of thing can and does go on everywhere. It also gives me an opportunity to relive how much fun it is for us lawyers when a US company discovers an employee doing this sort of thing.

We also once had a client that sold $1500 consumer products and received a complaint email from one of its retailers claiming to have received more than $80,000 of product in less than stellar condition from “XYZ distributer.” This email alarmed our client as it had NO distributers and it had no record of any sales to this retailer. To make a long story short, the profit margins from selling millions of dollars of products that cost you nothing to make are astronomical.

This sort of thing — what some call a company within a company is very common in China. See this classic Financial Times story from many years ago. So common in fact that when our China lawyers have been involved in confronting employees that engaged in such conduct, their usual reaction is not one of “I’m really sorry, go ahead and fire me, but rather something more like the following:

  • You never told me I could not do this.
  • The employer rules and regulations do not prohibit this so I did it.
  • If you fire me, I will sue you for xyz.
  • If you fire me, I will report you for xyz.

We typically advice our clients not to confront China employees that have gone rogue without first making sure that they have good grounds for termination and that such a confrontation will not be putting the company at great risk. See China Employee Termination: Avoid These Mistakes.

What though can and should you do to prevent this sort of thing from happening to you in China?

  • Recognize that you cannot just turn over your China operations to any one person and essentially just walk away. Do not have a business in China unless you are prepared to operate it and monitor it.
  • Do not put too much trust into a small core of employees, shutting out the lines of communication to the other employees, and failing to engage in even basic monitoring of the business.
  • Listen to your China employees and talk with your China employees. It is a big deal for one Chinese employee to “rat” on another, but in most instances where we have come across “a company within a company situation” there has been at least one employee who has been hinting at problems and the foreign office has just shrugged them off. Oftentimes, the employee will have sought to convey information about the problem in the form of a question, such as “do you think it might make sense to have our books audited early this year” and then been “shot down” by a foreign office that does not press for why this question is being asked.
  • There are certain “tells” for which you should also be looking. Is there a small group of employees that seem to want to block other employees from receiving critical information or data? Are you seeing invoices or purchase orders that do not make sense? Does what is happening on the ground look or even feel very different from what the books say.

I could go on and on with how to prevent this sort of thing and there are tons of articles out there on this as well. I will instead simply conclude by saying that this sort of thing is far more likely to happen to the company that believes it cannot happen to them than to the company that believes vigilance is necessary.

Not trying to scare anyone here, but do be careful out there.


This article was written by Dan Harris and published on China Law Blog. Original Post:      

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Dan Harris

Dan Harris is internationally regarded as a leading authority on legal matters related to doing business in China and in other emerging economies in Asia. Forbes Magazine, Business Week, Fortune Magazine, BBC News, The Wall Street Journal, The Washington Post, The Economist, CNBC, The New York Times, and many other major media players, have looked to him for his perspective on international law issues.