China Watch – A foreign lawyer’s view from the inside

We have now officially launched the Year of the Dragon in China, which should prove to be an interesting, if not auspicious, year for the China legal market given the announced merger of King & Wood (K&W) and Mallesons and the opening of the new Zhong Lun (ZL) office in London.

With this blog entry, I will embark on a new series on the China legal market to try to put the pending mega merger of K&WM and our own more modest international initiative into context and to suggest what this might mean for other existing market players, new entrants and (most importantly) clients.  The K&WM merger is without question the ’big splash’ event of the year in the China market, but its implications on the rest of the market are not entirely clear, and it is important that we do not lose sight of the many additional undercurrents to this critical but still (relatively speaking) under-developed market.  

Before I begin, I need to underscore that the comments and observations set out in this blog represent only my personal views and opinions and, notwithstanding my somewhat honorific title within my firm, should not be seen an official position of Zhong Lun.  So with that caveat, let’s embark on a trip down memory lane to trace the remarkable development of the Chinese legal market which has brought us to this point.

While many Chinese lawyers point to 1979 as the time of the reinstitution of the Chinese legal profession following the long period of dormancy under Mao, for our purposes we only need to go back not quite 20 years to 1993.  That is the year private Chinese law firms were first permitted to be set up – previously, Chinese law firms had been ’sponsored’ by state-owned companies or organizations.  K&W, ZL and many other top Chinese law firms were set up at that time.

That same year the PRC Ministry of Justice issued the first batch of approvals for foreign law firms to set up a representative office in Beijing – my former firm Lovells was in this first group of five foreign law firms, which were drawn from five different jurisdictions.  I wasn’t with Lovells at the time, but I understand that Lovells’ inclusion on the list was a bit of a happy accident.  Lovells’ management in London reportedly was caught a bit by surprise by the granting of the license and wasn’t quite sure what to make of it or what to do about it.  (That may explain why when I joined the firm eight years later in 2001, the Lovells Beijing office was comprised only of me, one junior lawyer recruited from our Hong Kong office and a small office staff.  Remarkably, that still put us within shouting distance of the small group of leading foreign law firm offices in China, which were still quite small in scale, at that time.)

Coincidentally, 1993 also marks the year I first came to the China market, joining the China practice group of Baker & McKenzie in Hong Kong after seven-plus years of practice in Los Angeles.  It was my great good fortune to land in Bakers’ China team because at that time there were only a handful of foreign law firms with active China practices, and Bakers was the clear market leader. 

I was already fluent in spoken Mandarin and written Chinese at the time, although not in a professional legal context.  My only language test was in my interview with the iconic Bakers China head Mike Moser, who asked me to read the title of a Chinese book on the shelf in his office – I got lucky, since all the Chinese characters were within my existing reading vocabulary.  I was also mostly house-trained as a lawyer, having spent six of my years in LA with Sidley & Austin, but I knew nothing about Chinese law. 

This turned out to be a good news/bad news situation.  The good news was that there were only about a dozen key Chinese laws and regulations relevant to our practice, which could be read through fairly quickly.  One could be deemed an expert on published Chinese foreign investment law in a few short weeks or months.  The bad news was that the codified law was not as important in China as how officials interpreted and applied these regulations and how they filled in the enormous vacuum created by the absence of laws and regulations with unpublished ’policy’.  Such ’policy’ in China is as elusive today as it was 20 years ago, and then as now it takes time and experience for a foreign lawyer to get a good feel for the perverse predictability of the unpredictable gyrations of Chinese policy. The main difference today is that Chinese laws and regulations are now so voluminous that no single foreign or domestic lawyer can be considered to be an expert in more than a couple of areas – the days of the jack of all trades in the China legal practice have long since passed.

So what was the state of play in the Chinese legal market almost 20 years ago?    Let’s start with the clients.  They were, for the most part, all Fortune 100 industrial companies from the US and Europe that had the resources and patience to penetrate the fog of China regulations and policy to set up manufacturing plants in China, which was essentially all that was open for foreign investors at that early stage.  You also had some foreign banks and infrastructure companies doing major projects.  The service sector was closed, and the flood of SMEs was still a decade away.  Other than Hong Kong and NYSE IPOs, Chinese companies were not a source of fee revenues for foreign law firms, and foreign lawyers and accountants were tolerated by Chinese issuers in these cases only because it was the only way these companies could access the foreign capital markets.  In sum, it was very much a legal services market dominated – almost completely – by the very elite multi-national companies.  

These foreign multinationals all gravitated naturally to one of the handful of US and UK law firms with a China practice.    The deals may have been in China, but the deal makers were all in Hong Kong, so that’s where the China practices of these US/UK law firms were located.  The trend towards moving China practice lawyers into Beijing and Shanghai had just started, and was in the process of being regularized with the adoption of the regulations on foreign law firms, which required foreign law firms to choose only one city in which to open a formal office.  Most set up in Beijing in those early days (and we will see in subsequent blogs in this series that Beijing has retained, and built on, its indisputably dominant position in the Chinese legal market), but a few, including Clifford Chance, set up initially in Shanghai.

All of these foreign law firm offices in Beijing and Shanghai were very small.   When I was moved up to the Bakers shadow office in Shanghai in 1994 (for what turned out to be only a few months as we were unceremoniously kicked out on the grounds that this was an unapproved second office – a tale worth telling, but we will save this for another time), we only had a couple of foreign lawyers and a few Chinese ’paralegals’.  The Bakers Beijing office was larger, but not by much, in large part because the Ministry of Justice was intent on controlling the growth of the foreign law firms in China by refusing to register more foreign lawyers – no registration, no work visa.  But it was also a hardship posting at that time, and most China practice lawyers preferred the creature comforts of Hong Kong.  There was,  and still is, also a significant tax hit for those moving up from Hong Kong into Beijing or Shanghai, which the firms needed to accommodate in an appropriate – and legal – manner.  As a result, for most of the 1990’s these foreign law firm offices in Beijing and Shanghai were relatively few in number, small in scale (generally no more than a dozen legal staff), and were thralls to their respective China group heads sitting on the thrones in Hong Kong.       

So what of the Chinese law firms in the 1990s?  For most of the decade they were not even on the radar screen.  The multinational clients that dominated the demand side of the legal services market never hired Chinese law firms in the early days except to sign an opinion letter drafted by foreign legal counsel (foreign practitioners could not issue legal opinions on Chinese law or appear in Chinese courts, but the black letter Ministry of Justice rules to the contrary notwithstanding, foreign law firms had full scope to offer advice on Chinese law and practice – more on these regulatory aspects in a subsequent blog). 

As China practice lawyers in a foreign law firm during this time period, we almost never considered it useful to consult with Chinese law firms for general legal advice – the advice we got back was uniformly either (1) a turgid recitation of chapter and verse of some Chinese law or regulation which often was only tangentially related to the issue, with no analysis as to the practical commercial application to the facts of the case, or (2) a summary of no-name (at least we hoped they were no-name) telephone consultations with some government official, who may or may not have authority to take a view on the relevant prevailing “policy”.   Our large multinational clients took a similar view and never asked us to consult with Chinese lawyers because it was generally considered unnecessary and unhelpful, except for matters which had to go to court, since most matters did not require a formal legal opinion.  I certainly took this view when I was the Asia general counsel for Nortel after my 3-year stint at Bakers.  In short, in this early time period the Chinese law firms were consulted only when absolutely required to provide a legal opinion or go to court, and they were ignored with full impunity in all other cases.

Case in point.  While at Bakers, we acted for the lead arranger for the foreign bank syndicate providing limited recourse project finance for a water treatment plant project in Shanghai.  This was the first so-called BOT project in China.  The banks needed a Chinese legal opinion so they could tick the box on their internal forms to get credit approval, so we engaged a then prominent Chinese firm based in Pudong in Shanghai.  During the course of the deal negotiations, central government authorities in Beijing issued a notice requiring all BOT projects be submitted to the central government for approval.  This created a dilemma for us since this was a Shanghai municipal government deal, and we knew that they would not be keen to kow-tow to the central government authorities in Beijing.  So I called up our friendly Pudong lawyer to see how he was going to deal with this new notice in his legal opinion. 

Astonishingly, he wrote back and said that since the Shanghai municipal government was on par with the State Council in Beijing in terms of authority it was not necessary to comply with the new BOT notice.  That was clearly nonsense from a pure legal analysis perspective – it was one thing to say that the Shanghai parties would ignore the notice and not be subject to any penalties as a practical matter, but as a matter of professional responsibility a lawyer could not simply ignore the new notice, at least not on the grounds stated, and particularly not in writing. 

I called the client and explained the situation and our concerns.  He only asked one question: “Will the Chinese firm give a clean opinion?” I reluctantly replied in the affirmative.  “Don’t call me again with this issue,” he instructed firmly and curtly.  The client knew that the Chinese law firm shouldn’t give a clean opinion in such a case, but he also knew that he needed a clean legal opinion to get credit approval, and since the Shanghai parties would in fact not submit the project for approval in Beijing and nothing bad would happen, the better choice was to close your eyes and hope for the best.  In the end he, and the Pudong lawyer, were right on the gut call – the deal went ahead without Beijing approval – but it was also a tacit confirmation that we all knew (wink and a nod) that in those early days no Chinese legal opinion was worth the paper it was written on, and we could all just close our eyes and ignore even the astonishingly and obviously incorrect rationale supporting a clean legal opinion which would be ignored in any event.   

The Chinese client side was also not necessarily a significant source of business for Chinese law firms in those early days, at least on foreign investment projects.  For the first five years of my practice in China, I rarely saw a Chinese lawyer across the table, and it was a couple more years before I observed a Chinese party actually seek (or take) legal advice from their legal counsel.  On the same Shanghai BOT project referenced above, the Shanghai team was led by a ’dragon lady’ who was of the age that suggested that her middle school education had been interrupted by the Cultural Revolution.  Her negotiating style only reinforced this suspicion as she spent many sessions screaming at the foreign lawyers that the documentation was laughably incomprehensible (she must have been a wonderful Red Guard in her day).  Actually, the document in question was a translated version of a dumbed down short form agreement which was typical for such deals.  When I approached the local counsel for the Shanghai side (who showed up only occasionally when summoned) privately to seek their views, they said they thought it was acceptable in form and language.  But when I asked them to convey this to the dragon lady, they literally shook in their inexpensive locally manufactured boots – there was no upside to incurring the wrath of the dragon lady.  So we all suffered her continuing tirades and tried to wait her out.  Not a great business for Chinese lawyers being paid a pittance on a fixed-fee basis to represent the Shanghai parties on this deal.

So what are the take-aways from this brief tour of the early days of K&W and other Chinese law firms (including my firm, ZL)?  I suggest that there are two things to bear in mind:

·      First, there are many foreign China practice lawyers of my generation who are still stuck in the 1990s in terms of their views of Chinese lawyers.  In other words, they generally won’t use Chinese lawyers except when they have no choice.  This ignores the extraordinarily rapid development of the Chinese law firms in the last decade-plus, and is driven in large part by self-interest and a continually lax regulatory environment for foreign law firms.  The truth is that the former ugly duckling Chinese law firms are now beautiful and powerful (albeit still young adolescent) swans, and the China practitioners in the foreign law firms who are unwilling to acknowledge this dramatic shift in the China legal services market are in the process of becoming dinosaurs.  (There is still a more than ample market for foreign law firms in China, but it is not the same market as in the earlier period described in this blog – more on this in later instalments in this series.)

·      Second, in connection with the K&WM merger, much has been made about the fact that K&W, in comparison to Mallesons, has a relatively brief history of not quite 20 years.  But I am not sure you can count all of those years if you are making a true apples-to-apples comparison.  If you start counting only from when the top few Chinese firms were operating more as real law firms and taking a leading or at least a substantive role in deals, we are really only talking about 10-12 years or so.  That means that the firm culture is still being formed in most Chinese firms, and the practice capability and quality, while enormously improved from the early days recalled above, is not even from office to office or practice group to practice group. And, in the shared grand tradition of Chinese organisations and both foreign and Chinese law firms generally, some edicts and initiatives from the centre are not always implemented at the edges at the individual partner level. 

In short, it is a very young legal profession in China, so all the key players are also still young.  In the top Chinese law firms, there is still all the natural turmoil and angst as well as promise and energy of an attractive, maturing, robust adolescent – which begs the question: are Chinese law firms ready for marriage and all that entails?  It will be interesting to watch and see.     

Robert Lewis is international managing partner of Zhong Lun Law Firm, based in Beijing