Who Owns China’s Internet? The Sordid Side Of Legal Opinions

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Photo: Robert Scoble via flickr

In a post about foreign ownership in China’s Internet industry, Dan Harris at China Law Blog went into a brief discussion about the questionable structures some Chinese firms have used to list overseas (i.e.VIEs — I’ve covered this extensively in other posts).Nothing that these legal structures are weak, Dan responded to a question posed by China Accounting Blog’s Paul Gillis, essentially wondering about all the lawyers over the years who have issued opinions on VIEs:

What about all those lawyers? Don’t cry for them. Any lawyer worth his or her salt that was involved in a VIE structure wrote a lengthy CYA letter making crystal clear that VIEs were risky, that the whole purpose of VIEs is to usurp/circumvent Chinese law, that Chinese law is itself risky, and that nobody really knows what will happen to VIEs or for how long they will be allowed to exist.

I rarely do this, but I have to disagree with Dan here. Well, sort of. He is right that a lawyer should write such a letter, but I don’t think it usually goes down that way. And yet, you still don’t have to worry about them getting in trouble over this.

One thing to remember is that foreign firms, which are often the ones handling these transactions, are not allowed to issue opinions on Chinese law.

Let me repeat that, since you probably do not believe me. Foreign law firms are restricted by Chinese law in their scope of services. Technically, they are allowed to set up shop in China if they limit themselves to opinions on foreign law.

Yeah, yeah, I know. This is bullshit. Of course foreign firms deal with Chinese law every day. The Ministry of Justice knows this and allows it. It’s the one big bizarre fiction in the legal industry here.

But there is an important practical effect here. When a foreign law firm issues advice to a client that involves Chinese law, you will commonly see a disclaimer somewhere at the top (I’m assuming something like a memo format) that essentially says “We are not allowed to give you an opinion on Chinese law. Please do not therefore rely on this as a formal legal opinion.”

These memos are, of course, opinions on Chinese law! I’ve written hundreds of them, some at foreign law firms, and that disclaimer makes absolutely no sense whatsoever. It used to embarrass me before I realised that no one cared one way or the other. In many cases, it doesn’t really matter as a “formal” legal opinion is not requested, just informal advice (i.e. the client is using the advice internally).

However, some transactions do require a formal opinion to be issued by a lawyer. Many of these are financial transactions or those involving securities. If the opinion involves Chinese law, a foreign firm may not issue such an opinion!

So how does this work in the real world? Let’s say a venture capital firm hires a foreign law firm to assist with an investment deal, the target of which is a Chinese company. Both offshore and onshore legal matters are at issue, and a formal legal opinions are required.

With respect to the Chinese law part of the deal, more often than not, the foreign law firm will do all the work (and collect 99% of the fees), and then at the last minute, it will solicit a formal legal opinion from a licensed Chinese law firm. Often, the foreign law firm will even draft the opinion, using the Chinese firm merely as a rubber stamp to essentially say “Yes, this structure is acceptable, with the following caveats.” (Not all firms do it this way, of course, but the practice is common and has been going on here for over 20 years.)

Now, what happens if that legal structure (e.g. a VIE) is called into question at some point in the future? Well, some foreign firms might have protected themselves in the manner suggested by Dan. I certainly would, if I did the work at all. However, a lot of firms out there might just rely on that Chinese law firm opinion in combination with that ridiculous disclaimer, plus any oral or informal advice given to the client over the course of the deal.

In other words: “Hey, don’t blame us. We told you there were some risks. Besides, you know that we can’t issue formal opinions on Chinese law. If you really want to complain to someone (i.e. sue someone), you may wish to take a look at that Chinese firm that issued the formal opinion.”

So what about all those lawyers out there? Believe me, they’re not losing that much sleep over this issue.

This post got its big break in the blogging biz over at China Hearsay.

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