what we think

By Robin Tabbers

In recent months, I've encountered numerous companies grappling with challenges in their China operations, many of which were exacerbated by the travel restrictions during COVID-19. With international borders reopening, business leaders are uncovering significant issues within their local teams. This newsletter sheds light on common HR and operational risks, illustrated by a real-world case study, and offers actionable strategies to safeguard your business in China.

Unveiling Hidden Issues

Many companies have neglected close oversight of their Chinese subsidiaries, relying heavily on local management. This lack of direct supervision can lead to various problems, including (financial) mismanagement, unauthorised business activities, competing activities, and fraudulent practices. It's crucial to address these issues promptly and decisively.

Uncovering Hidden Challenges: A Case Study

What better to illustrate these than through an example? But first, let me be clear about this example: this is not a China-only challenge. This can and will happen in every country if adequate levels of subsidiary oversights are lacking. This is the nature of business.

During a recent engagement, we were contacted by a Canadian manufacturing company facing suspicious activities at their China subsidiary. After years of neglecting on-the-ground oversight largely due to travel restrictions, the company suspected fraud and mismanagement by the local team. We were brought in to conduct a thorough investigation and take immediate corrective actions.

Part I: Summary of Actions

1. Initial Raids and Findings: After initially investigations of rumours, financial books, and public registry resources, our team arrived at the local factory, immediately securing financial documents and company stamps. Despite initial shock, the finance staff cooperated, revealing additional entities controlled by local management.

2. Interview and Evidence Collection: Through intensive questioning, we discovered a scheme where the General Manager sold products to a related company at low prices, then resold them at market value. Additionally, fake employee records inflated payroll expenses, funneling money back to the General Manager and their accomplice.

3. Financial Misappropriation: Detailed analysis of financial records showed that they had embezzled significant amounts through fraudulent service fees and sales invoices.

4. Confession and Recovery: Under pressure, at the threat of criminal charges, the General Manager admitted to their actions and agreed to return the embezzled money with a total of more than USD 1,000,000 transferred back on the spot ! Both the General Manager and their accomplice were terminated immediately.

Part II: Post-Raid Actions

1. Employment Compliance: We initiated a comprehensive review of employment contracts, social security contributions, and salary calculations. Implementing new contracts and an Employee Handbook will help prevent future discrepancies. Social security payment were adjusted to meet legal obligations.
2. Financial Compliance: Our team continues to oversee and build robust systems for financial reporting and statutory filings to ensure ongoing compliance. We provide a full suite of services, including accounting, tax compliance, and treasury management.
3. Intellectual Property Protection: Securing trademarks and domain names is essential. We have successfully registered relevant trademarks and domain names to protect the company's intellectual property from creative employees or competitors with ill intentions.

Key Takeaways

1. Act Upon Suspicion: Look for red flags such as inconsistent financial reports, unusually high expenses, or resistance to audits. Rumours sells the news, but they are often with merit. Where smoke is, there is fire. Immediate action by seeking local trusted provider support can prevent further damage.
2. Conduct Thorough Investigations: Engage experts to audit financial records, review communications, and interview key personnel. This will help uncover hidden issues and gather evidence for corrective actions.
3. Implement Robust Controls: Establish clear policies, conduct regular audits, and maintain direct communication lines between HQ and local teams. Regular oversight is crucial to ensure compliance and transparency.
4. Seek Preventive Professional Assistance: Employ legal and financial experts from the start or before becoming aware of discrepancies, as to navigate complex regulatory environments and manage finances and sensitive HR issues effectively. Distance is not a valid reason for less oversight and control levels that you would have for subsidiaries closer to HQ.

Next Steps

To mitigate risks and ensure smooth operations, consider the following steps:

• Regular Audits: Conduct periodic financial and operational audits to maintain transparency and accountability.
• Strengthen HR Policies: Update employment contracts, create comprehensive Employee Handbooks, and enforce conflict of interest and reimbursement policies.
• Enhance Communication: Foster open and transparent communication between HQ and local teams to build trust and facilitate oversight.
• Utilise Local Expertise: Partner with local legal and financial experts to stay compliant with evolving regulations and manage finance and HR complications.

Navigating the complexities of managing operations in China requires vigilance and strategic oversight. By addressing these hidden challenges proactively, companies can safeguard their investments and ensure sustained success in the Chinese market.

For more about how we can help foreign companies with maintaining and regaining control over local operation, please contact tabbers@rplawyers.com or your usual contact at R&P.  We are here to help you make the best decision.

This was originally published on LinkedIn as an edition of Robin's China Business Navigator Newsletter. Subscribe here to get regular updates.