Where Lawyers Can’t Practice

Practicing law means something totally different to International law firms in China.  What is the attraction for US law firms in China?  What can (and, perhaps more significantly, can’t) foreign lawyers do with China law and practice?  Have all firms successfully made the adjustment?  Who is the “Red Circle” and what impact will they have on the market?  What impact does the China Government have on the country’s rule of law?  And, how with the new US administration coming in, what impact will that have on China international law.

This blog was originally published by Insight, and was posted with permission of AmCham.

In the 1990s, China opened its legal services market to foreign law firms. Twenty years later, about 170 foreign firms have seized the opportunity to enter an environment of uncertain prospects. Foreign firms have responded to the country’s unique challenges differently: some firms have deepened their ties through mergers with Chinese law firms, while others have closed shop (most notably multinational firm Fried, Frank, Harris, Shriver & Jacobson LLP in 2015, and Cadwalader Wickerhsam & Taft stating that it will leave China by the end of 2016).

A unique legal environment

There is no obvious reason for a foreign law firm to come to China. The challenges start with the law itself. There is “inconsistent application of law by the local bureaus,” said Kilpatrick Townsend & Stockton LLP co-chair of Asia Practice and partner Gentry Sayad. “What may be true in Shanghai may not be true in Beijing.” Because of this, lawyers must spend more time looking at how the law has been applied throughout the country. “What clients would think is a simple question always requires more time and investigation,” said Sayad.

Even if the laws were consistently applied, the different emphasis on legal precedents poses another problem. Legal precedents do not have the same influence in China as they do in many developed nations. While in their home country a lawyer might be able to reference previous decisions as they advise their clients, they cannot have the same assurance that past decisions will influence future ones in China. Whatever the virtues or vices of Chinese law, it can also be a political tool, enforced (or not) as befits political ends. This environment limits the authority precedents otherwise held in developed countries, and poses a unique challenge for China’s lawyers.

Because of the law’s inconsistent application across regions and the challenge posed by precedents, foreign lawyers in China must pay special attention to government relations. “You need to get answers for your client without spending an inordinate amount of time doing it,” said Sayad. To do this, he says, it’s important to figure out how to “get the government guy to say ‘yes.’” Sayad noted that it is common for government officials to deny requests from foreign companies.

While in their home country a lawyer might be able to reference previous decisions as they advise their clients, they cannot have the same assurance that past decisions will influence future ones in China.

The government relations work that lawyers do is also important as they help companies who are making legal claims. “[The government] is not going to make any effort to proactively gather evidence, so really it’s up to [the company] to find the evidence on a company’s behalf and provide the narrative. And with the assistance of counsel, tie it up neatly with a bow and say ‘Here you go. Here is why you’re allowed to do this,’” said Sayad.

Differences for foreign firms

All of the above difficulties impact foreign and Chinese law firms alike. But foreign firms face unique restrictions that add to their operating challenges.

“Foreign firms are technically prohibited from practicing Chinese law. They are allowed to interpret and guide their clients on how to operate in China, but technically speaking they cannot practice Chinese law. The two clear indications of practicing Chinese law would include appearing in front of a Chinese court and they cannot give legal opinions under Chinese law,” said another international lawyer.

Sayad agrees: “Foreign lawyers are restricted from giving opinions on Chinese law, and to the extent we advise our clients on legal matters in China, it is either in coordination with Chinese local counsel or it’s based on publicly available information and our experience as foreign lawyers registered in China.”

How these restrictions affect Chinese law licenses

Note that these restrictions are on foreign firms, not simply foreign lawyers: Chinese lawyers that join foreign firms must give up their Chinese law licenses. These restrictions frustrate foreign firms, particularly since the inverse is generally not true. As the U.S.-China Business Council’s 2013 report on “Legal Market Access Issues in China” notes, “U.S. regulations permit Chinese law firms in the United States to hire U.S.-licensed lawyers who may practice in the United States without similar restriction.”

In 2001, when China acceded to the World Trade Organization (WTO), access to the country’s service industry was largely liberalized. Foreign accountants, for instance, could begin practicing in China. But law firms did not receive the same welcome. As attorney Mark Cohen noted in a 2012 paper: “Market access liberalization offered to foreign law firms at WTO accession was comparatively small, and was largely limited to permitting foreign law firms to open up more than one representative office. However, such offices continued to be restricted in the type of services they could provide.”

The restrictions are clear, but not all lawyers agree that they are a problem. For instance, Qiang Li, co-country managing partner for China at international law firm DLA Piper, argued that “the degree of openness of the legal services sector is commensurate with the amount of opportunity that exists for the international law firms at this point.” While he can imagine “more liberalization of the legal market as China’s legal reform progresses,” he believes that there simply “aren’t enough opportunities for the market to be completely opened up to everybody.” Nevertheless, foreign lawyers still eagerly await the liberalizing changes that will give them market access akin to their service-industry peers.

Firm partnerships and mergers

In the meantime, successfully navigating China’s legal services industry and providing their foreign clients with the service they expect in their home countries has required foreign law firms in China to partner with their Chinese counterparts. Sometimes that partnership comes through M&A: two notable examples being the three-way merger between Australia’s Mallesons Stephen Jaques, Britain’s SJ Berwin and China’s King & Wood in 2013, and the merger of global law firm Dentons with China’s Dacheng in 2015. These mergers received a lot of attention within China’s legal industry, and the industry is watching closely to see whether they will succeed or fail.

Many lawyers assume these mergers are riddled with challenges. One reason is pricing differences. In major markets like New York City, first-year associates at major law firms are paid an average base salary of US$160,000. Conversely, a first year associate at a major firm in China can expect a base salary of approximately $50,000 plus discretionary bonus. When firms like these work together, an international lawyer says, “you’re looking at a very different business model and a very different cost basis.”

That China’s legal services industry is at an earlier stage of development than many of their Western counterparts is another potential sticking point. Private law firms have only been allowed in China since 1992, and in 2015 The Economist reported that the legal sector constituted 0.1% (US$7.6 billion) of China’s GDP, compared with the more than 1% average contribution from the sector in major European countries.

Chinese law firms have offered increasingly high-quality service, but quality assurance cannot always be assured across a firm. In the United States, says Sayad, “I can pick a big firm that everyone knows and be pretty sure that whatever office I call, I will for the most part get a quality lawyer and quality service. But in China that’s still developing. A firm that’s got a great office in Shanghai might still not have developed sophistication in Guangzhou.” The reputational risk that could come from choosing a partner of inconsistent quality is worrying for some foreign firms, and is one of the reasons why many firms choose to work with a variety of Chinese firms on a case-by-case basis. This is the road that Kilpatrick Townsend & Stockton has taken in Shanghai. “We work with some great Chinese firms on different matters and around the country,” says Sayad.

What makes it worthwhile?

These challenges are sizeable, but dreams of future returns have encouraged many foreign firms to endure them. As Chinese companies have grown and begun to spread their influence overseas through outbound investment, foreign law firms have endeavored to win M&A mandates from these transactions.

While, as an international lawyer notes, “20 years ago [foreign firms] focused mostly on supporting the China operations of their clients from Europe or the United States,” building relationships and trust at Chinese companies so that they can be involved in future outbound investment transactions seems to be the new motivation.

Focusing on outbound investment might also prove a strategic way for foreign firms in China to differentiate themselves from increasingly sophisticated Chinese firms. There are more than 19,000 Chinese law firms, and as these firms develop, they are beginning to gain the capability and reputation to represent foreign clients on their own. Notable leaders in this maturing market are the “Red Circle,” the term used for eight Chinese top-tier law firms, which includes King & Wood Mallesons, Jun He Law Offices, Fangda, Zhonglun, Haiwen and Partners, Commerce & Finance, Global Law Office and Jingtian & Gongcheng.

Because of the aforementioned differences in pricing models, these law firms are usually able to serve clients more cheaply than their foreign counterparts. To fend off the increasing competition, foreign firms are leveraging their understanding of their home market to entice more Chinese clients.

Building trust with clients is a main priority

Whether or not they become a profit center, many international firms see the value of maintaining a presence in China in order to support their clients. “I think people came here because their current clients wanted them here,” says Sayad. “I suspect that some of the offices are not very big revenue generators.” Li echoes this feeling, noting that “because international clients have a tendency to distrust the [Chinese] government…international firms can play a very important intermediary role.”

The future for China’s legal services sector is largely dependent on how the country’s rule of law develops. And much encouragement for that reform, Li argues, will come from China’s domestic law firms. “Domestic firms have scaled so much and might be a factor in China’s legal reform – getting the government to acquiesce to building a more rule-based society, rather than just a government-dominated society,” he says. “These law firms are getting very big and they will have to do something. If the government continues to dominate, they will not be able to play an important role.”