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July 21, 2017 | Author: CHEUNGB2 | Category: Joint Venture, Employment, Mergers And Acquisitions, United States Labor Law, Labour Law
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China Foreign Investment Legal & Tax Advice From Dezan Shira & Associates


Volume VIII - Number X





International language editions also available as a complimentary subscription service at

December 2007



In This Issue: Background to the new Labor Contract Law effective January 1, 2008 New Employers Liabilities New Contractual Obligations – written forms, probation periods, confidentiality clauses, noncompetition, fixed & open ended contracts, part-time employment and payment of wages New Severance & Termination rules What Foreign Invested Enterprises need to prepare for with existing and future staff Plus: The Best of the China Briefing Blog – our round up of all the past months need-to-know China business news


Welcome to this issue of China Briefing

Welcome to the December issue of China Briefing and a timely examination of exactly what needs to be done to prepare your China invested business for the new labor law regulations that kick in January 1, 2008. Foreign investors must get themselves into compliance and be prepared so they don’t inherit potentially huge increases in overheads and liabilities.

Chris Devonshire-Ellis Senior Partner, International Practice, Dezan Shira & Associates; Publisher, China Briefing

We provide a background to the new law, in addition to the implications, and importantly, what you need to do beforehand to prepare for it. The subject is a huge topic that affects every business in China. If you need assistance with preparing for these changes then please contact the firm Dezan Shira & Associates urgently at [email protected] For ongoing up-tothe-minute comment of matters affecting your China business, please also visit our award winning China Briefing blog at Meanwhile, in what has been a watershed year for many businesses in China, may we wish all clients of Dezan Shira & Associates and readers of China Briefing a Very Merry Christmas and a Happy New Year. We’ll see you in 2008!

Alberto Vettoretti Managing Partner, China Practice, Dezan Shira & Associates; Vice-Publisher, China Briefing

With best regards;

Chris Devonshire-Ellis

Sabrina Zhang, Tax Partner, China

Alberto Vettoretti

Sabrina Zhang

Equity Partners, Dezan Shira & Associates, Publishers, China Briefing


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This Month's Cover Art: Utopia. No. 59 by Zhu Wei Workers of the world unite! In “Utopia,” artist Zhu Wei captures the unionizing spirit of the new labor law. Drawing equally from the school of impressionism and traditional communist themes, the piece’s vibrant colors and striking imagery deftly combine two very disparate art styles, giving the artwork energy and power. A native of Beijing, Zhu studied at the People’s Liberation Army Academy of Art, the Beijing Film Academy, and the China Institute of Art. Zhu made his first international appearance in 1993 and since then, has put on more than 20 individual exhibitions worldwide. Zhu devotes himself to contemporary Chinese art themes using ink and color on paper. Image courtesy of the artist and ASpace Gallery, Beijing

All materials and contents © 2007 China Briefing Media Ltd. No reproduction, copying or translation of materials without prior permission of the publisher. Contact: [email protected]

The Labor Contract Law of the People’s Republic of China

The Labor Contract Law of the People’s Republic of China [ By Richard Hoffmann, Senior Associate, and Stefanie Knirsch, Dezan Shira & Associates Beijing Office ]


Foreign investors have to be in compliance with all the laws and regulation of the PRC – even if local Chinese companies are not. Foreign investors are the number one target of legal and financial control mechanisms in China. Before the Chinese authorities check local companies' compliance issues, they will check the foreign investor. Therefore, a foreign investor has to make sure they are in compliance with China’s often changing laws and regulations. If you are not sure that you are in compliance, you are well advised to work with someone who can help. Make sure that your Chinese documents are in compliance with all laws and regulations. You are in China, only the Chinese version is the binding one.

A new labor law On June 29, 2007, the Standing Committee of the National People’s Congress adopted



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However, our experience has shown that these rules are poorly enforced, particularly in rural areas. In spite of existing labor laws, companies still underpay their staff, require them to work for extreme periods of time without rest and ignore health and safety measures. Many cases in which we have conducted due diligence with companies in China, we have come across non- or under-payment of wages or social welfare. This can be especially dangerous when acquiring companies or parts of companies as one may acquire all the liabilities as well.

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hina’s economy is booming and a more active participation in the global marketplace requires stricter laws and regulations in compliance with world standards for working and employment conditions. China’s labor law of 1994 provided a basic framework for employer and employee relationships. It was meant to be a guideline for companies in order to protect workers from poor treatment and hazardous working conditions.

Medical House the Labor Contract Law of the People’s Republic of China, set to come into effect January 1, 2008. The law applies to all employers within the People's Republic of China. In addition to commercial enterprises, it must be followed by government agencies, public institutions and social organizations. It governs the establishment of employment relationships as well as the performance and termination of employment contracts. The provisions prescribed by the law are meant to discourage employers from signing short-term labor contracts and will have a direct impact on employment costs. The aim of the new law is to improve the employment relationship, clarify rights and obligations of employees and employers and provide more stability and security for the employees in the PRC.

In this article we will mainly focus on the implications for foreign invested enterprises (FIEs). The law will considerably change the requirements for both employer and employee and requires many companies, both foreign and domestic, to review their labor contracts. The new labor law is part of the general trend to unify legislation relating to domestic Chinese and foreign invested enterprises, although some people fear that the fast, and to a high degree compliant, implementation of the law by FIEs might lead to disadvantages versus local competitors.

Employer’s liabilities Employers are liable for damages caused by invalid contracts, lack of mandatory minimum content in labor contracts, violating laws by company rules or failure

China Briefing | December 2007


to issue termination certificates. Penalties can be imposed by the authorities in cases where the employer keeps the employees ID card or collects security deposits from their employees, and when salaries are not paid in time or below the locally stipulated minimum levels. The same is true of nonpayment or no additional rest time for overtime work and nonpayment of severance pay after termination or expiration of labor contracts. Items that must be included in the labor contract company name, address and legal representation employee’s name, address and personal ID number term job description and location working hours, rest and leave compensation working conditions workplace safety/protection protection for job-related hazards social insurance

Written forms Make sure that you have written contracts. A written contract must be signed by both parties to establish the employment relationship. If the employer fails to enter into a written contract with an employee for more than one month but less than 12 months, the employer shall pay the employee twice the salary for every month without a written contract. As stated in Article 14 of the contract law, if there is no written contract

concluded for 12 months or more after commencement of work, the contract is deemed to be open-ended. Oral contracts are only permissible for part-time labor.

Implications for investors Well drafted labor contracts will become increasingly important. If a contract violates applicable laws, excludes the employees’ rights or relieves the employer from his responsibilities, the labor contract becomes invalid. The same rule applies when the employer exerts deception or coercion on the employee through the contract. Look for good advice if you are not familiar with these issues.

Probation period The parties can agree on only one probation period that cannot be extended. The law requires employers to pay their employees at least 80 percent of their contractual salaries and not less than the locally stipulated minimum salary. The maximum probation period is based on the term of the contract, thus: no probation period applicable if the contract term is less than three months one month, if contract term is between three months and less than one year two months, if contract term is between 12 months and less than three years six months, if contract term is more than three years Currently a lot of one-year fixed-term contracts have a probationary period which amounts to three months. This will not be possible under the new law. The probationary period cannot be longer than one month for a one-year fixed term contract; that is the maximum. But the situation chances completely with one additional day. If the term of the fixed term contract is one year and one day – the probationary period can than be two months. In case the employer fails to comply with the statutory probation periods, compensation following the salary standard applicable to the employee after the probation period has to be paid. Under certain conditions the employee may terminate the employment contract with immediate effect (e.g. if the employer failed to provide the working conditions as stipulated in the employment contract


China Briefing | December 2007

or failed to pay remuneration on time and in full). The employee may also still be able to ask for severance. An employer is not required to give a written notice prior to the termination of the contract during the probation period. Termination of contract is only possible however, if the employee does not meet the recruitment requirements. The employer will have to explain the reasons for dismissal to the employee. In that case no severance pay is required. However, the situation is different if the employee wants to terminate the contract during the probationary period: The employee is obliged to give a threeday prior notice to the employer, before terminating the contract. If the labor contract is project based or has a fixed-term of less than three months, there can be no probation period.

Implications for investors Employers have to be more careful when hiring new staff; to even terminate an employee during the probation period requires sufficient evidence. The probation period is not allowed to be extended, if the employer asks an employee to perform a longer probationary period, the matter can be brought to the attention of the local labor department and rectification can be ordered. Compensation payable is based on the amount of the employee’s monthly salary at the time the probation period was completed multiplied by the extra period served as probation period.

Confidentiality clauses Provisions on confidentiality with regard to maintaining the confidentiality of the trade secrets of the employer and to intellectual property may be included in the contract. If the obligations agreed in the contract are breached and cause the employer to suffer losses, the employee will be liable for damages.

Non-competition The employer and employee may enter into a non-competition agreement; however, such an agreement should be limited to senior management personnel, senior engineers and any other employees having confidentiality obligations. There are no restrictions regarding the scope, the geographic area and the terms.

The Labor Contract Law of the People’s Republic of China The maximum duration of the noncompetition period is two years. Noncompetition is particularly critical for FIEs, as their projects often involve significant know-how and technology transfers. The non-competition obligation is tough: the employee is not allowed to work for a competing employer that produces the same type of products or is engaged in the same type of business. An employee is restricted from establishing their own business in order to produce the same type of products or engage in the same type of business. The employee is liable to pay penalties “as agreed” and for damages caused.

days. No written contract is necessary and a part-time employment can be terminated at any time – monetary compensation is not payable.

An employer has to pay for a noncompetition agreement: the law requires “compensation on a monthly basis” for the employee during the term of the competition restriction after the termination or end of the employment contract.


Payment of wages An employer is obliged to pay the salary, in accordance with the national regulations and the provisions of the employment contract, on time and in full. Under the current law, employees must hand in their complaints against unpaid wages at a labor arbitration tribunal; from 2008 onwards, they will be able to ask the court directly for an order to pay.

Fixed and openended contracts Different from earlier drafts, the termination rights between the fixed and open-ended contracts are the same. Open-ended contracts are concluded if: the employer and employee have mutually agreed to do so the employee has been working for the same employer for ten consecutive years the second fixed-term contract expires and the employee requests or agrees to renew the contract (please note that this only applies to fixed-term contracts entered into on or after January 1, 2008) the labor contract has not been signed for one year or more

Part-time employment Part-time employees should work no more than four hours per day and no more than 24 hours per week for an employer. The maximum payment schedule is 15

The employer may also terminate a contract by giving the employee a 30day written prior written notice; or one month’s in lieu of notice if: after the set period of medical care for an illness or work-related injury, the employee can engage neither in his original work nor in other work arranged for him by his employer the employee is incompetent and remains incompetent after training or adjustment of position a major change in the objective circumstances relied upon at the time the contract was written renders it unfeasible and, after consultation, the employer and employee are unable to reach agreement on amending the labor contract

Termination prohibited

Implications for investors Consider the use of non-competition clauses carefully – it could be an expensive but necessary burden. If an employer does not pay compensation, the employee will be released from any non-competition obligation.

affects the completion of tasks with the employer, or when asked, refuses to rectify the matter.

Expiration and termination of labor contracts By employee As stated earlier, the employee may terminate the labor contract during the probation period by giving three days prior notice. After the probation period the employee may terminate without notice, if the employer uses violence, threats and other illegal means to force employees to work, or gives orders violating applicable rules and thereby puts their safety at risk. If workplace safety or condition is not provided, compensation or social insurance is not paid in full, the company rules violate laws or the contract becomes void, the employee may terminate the labor contract at any time upon serving notice. The employee may also terminate the labor contract upon serving 30 day notice in writing.

By employer Coming into immediate effect, the labor contract may be terminated if: the employee is found not capable of performing during the probation period; violates rules in a significant way; commits serious dereliction of duty or practices graft; becomes criminally convicted; establishes employment with another company which materially

If an employee suffers from work-related injuries and is under medical observation, or it can be proven that the employee has lost ability to work due to occupational hazards or diseases, termination is prohibited. To ensure the diagnosis of such injuries, an exit health check-up for those exposed to occupational hazards is mandatory. Employers should not terminate contracts during medical treatment periods, pregnancy, confinement or nursing periods. A special nontermination rule applies for employees that have worked for over 15 consecutive years for one employer and are less than five years away from retirement.

Severance and compensation after termination by fixedterm contracts Severance is payable if a fixed term contract expires and is not renewed. The compensation amount is dependent from the length of employment and the average salary for the twelve months prior to the termination or expiry of the contract. For every full year of employment with the employer, one month salary has to be paid. For a period of more than six months to one year, compensation is one month salary. For an employment period of less than six months, only half a monthly

China Briefing | December 2007


salary is required as compensation. The compensation may not exceed one year’s salary and the “average monthly salary” is capped to three times the average salary of the employer’s location as officially published. The new law explicitly allows payment in lieu of notice. If the salary is three times more than the local average monthly salary, the compensation shall be calculated according to three times the local average monthly salary.

Implications for investors Many FIEs use fixed term contracts. They should check in time whether their budgeting has to take the payment of severances into account – and to what extent. As termination against the law triggers a right of the employee to be reemployed, or additionally compensation obligations of the employer, namely payment of twice the stipulated severance amount, the employer has to be very careful. No severance pay is applicable if the employee: proposes the termination violates company rules in a material matter is derelict in duty or is terminated within the probation period due to incompetence is employed by another company which materially effects the completion of tasks, or the employee refuses to rectify the matter after it is brought to the attention of the employer the contract is invalid due to specific circumstances mentioned in Article 26 has criminal liability in accordance with the law dies refuses to renew when offered a contract with similar or better terms Important note: The employer is only allowed to terminate the contract based on the reasons mentioned in the new labor law (listing is exhaustive). In order to create more flexibility we strongly recommend drafting an employee handbook which could create additional reasons to terminate employment and attach it to the appendix of the labor contract. The employment handbook must: stipulate certain behavior as a breach stipulate the consequences (e.g. first time: verbal warning; second time:


China Briefing | December 2007

written warning; third time: contract termination)

Unions and employee representatives Unions and employee representatives protect the interests of workers. They may organize collective bargaining and have to be “consulted” on many instances, even though their agreement is not mandatory. They must be involved in mass lay-off and company policy making. Unions have to be informed if the employer unilaterally terminates labor contracts or establishes changes in regulations and policies concerning immediate interest of the workers, such as labor compensation, work hours, rest, work safety, insurance, and training. The trade union may render support and assistance for employees that apply for labor arbitration or file for litigation. Unions will enter into collective contracts. Industry-wide or regional collective bargaining is encouraged by the new law. A collective contract is binding on all companies or employees in the industry and/or region concerned. The stipulated terms must be above minimum standards specified by local regulations. Employees hired through staffing agencies are also entitled to participate in or organize trade unions.

Collective dismissals Mass layoffs (20 or more employees or 10 percent of the total workforce) are only permitted if the employer has consulted the union or employee representatives, and proposed the action to the labor departments in accordance with the law. Collective dismissals are only allowed if one of the following reasons applies: the company is undergoing restructuring according to the Enterprise Bankruptcy Law the manufacturing or operating capacity of the enterprise is severely limited the enterprise switches its mode of production, introduces major new technology or adjusting its operations and, following modification of employment contracts, still needs to retrench employees major changes have occurred in the objective circumstances under which the labor contracts were concluded, such that the contracts could no longer be performed

Priority must be given to employees who have a long fixed-term contract, openterm contract, or are the sole breadwinner in the family. If the employer decides to recruit within six months of a mass layoff, the dismissed employees should be notified, and if they accept the same conditions as new applicants, must be given the position.

Company rules

A specific procedure must be followed in order to validly adopt company rules. The terms and conditions must be discussed by the employee representative congress (ERC) or employees at large. The ERC/employees at large will put forward proposals or comments. The management then negotiates with the ERC/union and publicly communicates the new regulations and policies to the employees. Any charges or revisions to the company rules must follow the same procedure.

Staffing agencies The new law affects representative offices which use the service of FESCO or other staffing agencies. The requirements for the agent are the following: RMB500,000 minimum registered capital, two year contract with employee with monthly pay, even without actual employment. A company using staffing agencies services will have to pay overtime and performance based bonus and benefits, and apply the same pay standard and pay increase mechanism for all employees. The company may not send the employee

The Labor Contract Law of the People’s Republic of China to another entity than agreed in the contract. Please note that the agent and the company are both jointly and severally liable for a breach of contract.

Unresolved issues One of the main problems with labor laws in China is their enforcement. The central government drafts, passes, executes and enforces the law – there is no division of power on the mainland. That means a system of checks and balances found in most developed countries does not exist in China. Many companies from Europe and the U.S. complain that labor laws in China are weakly enforced against Chinese entities, which frequently evade or ignore the law, whereas U.S. and European companies are monitored very closely. This is not only a burden, but also a chance to create a fair and humane working environment for millions of workers employed directly by FIEs, or as part of the supply chain the company overlooks. It remains questionable how local companies will respond and how provincial jurisdictions will interpret the law. Like any new law in China, there is plenty of room for broad interpretations and the main problem with this remains the inherent vagueness and lack of clarity and consistency within them.

Implications of the Labor Contract Law for foreign invested entities The ultimate consequence of the new labor law will be the effective abolition of fixed-term contracts. Every fixedterm contract that expires creates a severance obligation. Without paying compensation, a problem employee

cannot be dismissed. Business costs will rise due to the higher expenses for hiring and terminating staff. Increasing obligations and legal requirements lead to declining employment flexibility and rising employment risk. However, those who have intently followed the previous drafts will notice that the cost increases could have been even higher. Companies will need to reassess their China HR capability and decide if someone should be designated to handle labor issues, if they do not have an established department. Possible solutions could be outsourcing or part-time employment. In all cases you should act with caution, especially when drafting contracts and company policies. Consider hiring a professional advisor to make sure contracts are in compliance with the new law and to avoid unnecessary administration and legal costs due to incomplete or worse, invalid contracts. Besides drafting the contracts and revising the pay structures, companies can also be proactively involved in the process of establishing an employee representation committee (ERC) or unions in order to build a strong and trusting communication basis. As collective bargaining will be reinforced, a good relationship with the ERC/union advances cooperation and may help influencing their decisions. The Labor Contract Law improves the power of unions and serves to inform employees better of their rights, which might encourage workers to do more to enforce better working conditions. The law is aimed at changing unfair labor practices that are not employed by most foreign companies (e.g. confiscating employee ID cards or collecting a security

payment to detain them is common practice in Chinese entities). Employers should... make themselves familiar with the new Labor Contract Law prepare basic contracts for new employees that meet the new legal requirements (in Chinese) prepare or revise employee handbooks review existing contracts and pay structures (open or fixed-tem, noncompete/confidentiality clauses, probation period arrangements) update or draft company rules establish an employee register and draft a termination certificate review cost impact and create annual provisions (severance, compensation) have HR connect with the union/ worker representation (expect collective bargaining, involvement in policy decisions) plan for increased labor costs in the near future extend existing contracts communicate and sign new contracts will all employee before 2008 review staffing agency arrangements (check for outsourcing options) Seek professional advise from Dezan Shira & Associates if you need assistance with the new labor law compliance. Contact: [email protected]

WAS THIS ISSUE USEFUL? China Briefing subscribers can access our archives, free of charge. If you found this issue of use to your business then we also recommend the March 2005 issue “China Human Resources” which details aspects concerning inheriting staff via JV’s, common fraudulent employment scams, and other HR due diligence matters. Chinese direct investment legal & tax expertise directly from Dezan Shira & Associates

China Briefing | December 2007


Best of the China Briefing Blog China Briefing’s award winning daily blog is an immensely useful resource, bringing you comments and updates on matters of China business as they occur. Fed by Dezan Shira & Associates regional office staff, the blog provides the only truly national China snapshot of what is going on and where – as it happens – with additional commentary from business leaders across the country. This section highlights some of the best articles from the China Briefing blog this past month. If it’s worth commenting on, the China Briefing blog covers it.

Dezan Shira & Associates celebrates 15 years in China

New guidelines on FDI creating confusion in the real estate sector The new catalogue for foreign investment, released on November 7, aims to address some of what Beijing perceives as structural problems in China’s economic development. Chief among these is limiting the inflow of foreign direct investment into industries that do little to tackle some of Beijing’s major problem areas – real estate, mining and non-renewable mineral resources, and conventional manufacturing. feature

Consumer prices in China pushed to tenyear high, low-income households feel pressure China’s consumer prices this fall reached the highest rates in more than a decade, driven mostly by skyrocketing food costs. While the government says that these price increases remain in line with the country’s economic growth, the impact on the lower-income families and individuals is going to become increasingly heavy. As the price of staple commodities continue to rise in China, so to will the anger and frustration of everyone who has been left behind by the country’s economy.

Tax breaks disappear in draft of corporate income tax implementation rules In late November, 1992, Dezan Shira & Associates began life as a Hong Kong limited liability company and opened its doors in Hong Kong and Shenzhen to begin providing consulting services to foreign investors wanting to get into China. To celebrate this – 15 years is a long time in China – we ran a series of articles looking back at those years. What it was like back then? What have we learned? The entire series can be found in our special reports section of the blog. w w w. c h i n a - b r i e f i n g . c o m / b l o g / specialreport


China Briefing | December 2007

China has drafted executive regulations for a new corporate income tax law that will harmonize the domestic and foreign rates, and the final draft has been submitted to the State Council for approval. The income tax rate for foreign companies in special bonded zones, which previously enjoyed a preferential rate of 15 percent, will rise in stages to 18 percent, 20 percent, 22 percent, 24 percent and finally 25 percent, the same as domestic companies, over five years, according to the final draft of the executive regulations for the new corporate income tax law. feature feature

China to shorten May break and add traditional holidays The Chinese government released is considering shortening the May 1-7 “Golden Week” holiday and establish three new legal holidays and has released a plan that will allocate holidays for Tomb-

Best of the China Briefing Blog Sweeping Day, the Dragon-Boat Festival and the Mid-Autumn Festival. The plan, released on the Internet in order to solicit public opinion, could come into operation in time for the 2008 Spring Festival if all goes well and there is a broad support among the public. According to the new plan the total number of legal holidays will increase from 10 days to 11 days. New Year’s Day remains a one-day holiday. The Spring Festival will still be three days, but will begin on the lunar New Year’s Eve, rather than lunar New Year’s Day. The National Day will also remain a three-day holiday with the big change coming from the shortening of the original three-day May Day holiday to one day so that new one-day holidays could be created for Tomb-Sweeping Day, the Dragon-Boat Festival and the Mid-Autumn Festival.

Consider Delhi and Mumbai, and compare them with Beijing and Shanghai. Investing in China means having an Asian policy, and the giants of India should not be ignored. Different yes, but often refreshingly so; they are democracy in action, and it is a comparable, and some would suggest better, environment than China’s oft shackled cities can offer.

Need more info? feature

Read the entire China Briefing blog archives at blog, Search for news and commentary by region or industrial sector and gain access to our special reports section with in-depth coverage of important issues as they occur.

China, top producer of greenhouse gases, looks to tap potential resource feature

Delhi – Beijing, Mumbai – Shanghai: Anything China can do, India can do too

China, plagued with both a growing pollution disaster and serious energy crutch, is looking for alternatives to its dependency on coal and other fossil fuels to power its economy. The recently concluded Methane to Markets Partnership Expo, co-hosted by the U.S. Environmental Protection Agency (EPA) and China’s National Development and Reform Commission (NDRC), attracted more than 700 participants from 34 countries to discuss alternative ways to decrease methane output while harnessing the gas as an alternative energy source. feaure

For additional information on living and working in China, please visit China Expat, featuring a monthly magazine, blog, Q&A forums and over 60 detailed China city guides.

For unique commentary on China-India bilateral trade, investment and relations, please visit

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China Briefing | December 2007


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• Tax Incentives Available to Foreign Investors

• Foreign Investors Audit Requirements

• Expatriate Individual Income Tax

• General Accounting Treatments on Significant Audit

• Business Taxes Affecting Foreign Companies • Withholding Taxes On Services Provided Outside China NEW !!!

Areas • What To Do If In Non-Compliance

China Briefing’s Guide To Mergers & Acquisitions in China • China’s M&A Environment

• Negotiation strategies

• M&A regulations concerning China Listed, State-Owned,

• Purchasing of bankrupt assets

Foreign Invested & Privately Held companies

• Converting Chinese companies to Foreign Owned Entities

• M&A transaction and acquisition structures

• Inheriting Labor Law & Tax issues

• Due Diligence – legal, financial and operational

• Common Mistakes in M&A

• Valuing a target company

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