Businesses restarting after the pandemic-induced pause face new legal headaches surrounding declines in demand and disruptions to global supply chains. How should in-house counsel manage these and other risks? Luna Jin reports
Perhaps necessity is also the mother of reinvention. BYD, a Shenzhen-based electric carmaker, recently received an order for 300 million N95 masks and 100 million surgical masks from the California government. With car sales suffering, the Chinese automaker has transformed itself into the world’s largest manufacturer of masks, with a reported capacity to produce 15 million a day.
The invisible hand of the market seems to have cast its magic in this case, aligning the fates of two disparate industries – automobiles and masks. BYD isn’t a unique case, and businesses across industries are repurposing their manufacturing facilities to fight the pandemic and keep their business afloat.
In a similar case, a Chinese ethylene supplier in the petrochemical industry, which used to provide finished and semi-finished products for automobile production, changed a part of its production line to produce melt-blown cloth, a fabric that plays a key role in mask production, in response to the pandemic.
This was a transition that was timely and astute. The supply of melt-blown cloth had fallen far short of demand because of the difficulty of expanding production in a short time, even for China, due to long investment cycles and the high cost of setting up a production line. The shortage had sent the prices of melt-blown cloth soaring by 40 times at one point.
“The pandemic has unleashed the potential of Chinese manufacturing,” says Jeffrey Quan, a senior partner at ETR Law Firm in Guangzhou. “Manufacturing is the foundation of economic recovery, and creative responses like this have not only brought profits to the enterprises themselves, but also contributed to the welfare of society and people’s livelihoods.”
Quan, however, notes that the ethylene supplier had issued “pandemic bonds” to raise funds, and the new business helps it fulfil the fundraising condition of producing “key medical materials”.
Mary Ma, general counsel at Chinese online travel aggregator Tongcheng Elong, says that, “innovative businesses are booming, which requires in-house counsel to have comprehensive business thinking and be able balance the commercial and legal risks in handling these new businesses”.
The pursuit of efficiency has deeply divided labour, and production facilities are spread around the globe in order to maximize cost saving. One consequence of that is an extremely fragile international supply chain with heavy dependence on specific regions or countries, such as China. Once the linkage is blocked, the ecosystem tumbles. This is particularly evident in emergencies such as COVID-19, when trade and logistics are curtailed, often leaving business leaders at their wit’s end.
Talk about “deglobalization” has become louder since the global transmission of the pandemic. The Economist magazine in May claimed that the outbreak had intensified deglobalization, and that it would accelerate the development of regional supply chains.
“The biggest issue facing the high-tech manufacturing industry is the short-term disruption and long-term layout adjustment of the global supply chain,” says Eric Xie, vice president and chief legal officer at Foxconn Industrial Internet.
Speaking of the need to examine the performance of core contracts in the current supply chain, Xie suggests: “For contracts in different countries and regions, it is necessary to combine [the opinions of] local teams with local laws, regulations and precedents for prudent analysis. Take force majeure as an example, in fact, there are substantial differences in judicial practices in different countries.
“The general counsel of sizeable enterprises should focus on the more strategic risk coming from supply chain-related contracts. In addition to the impact of the pandemic, we should also take into account the impact of sanctions, anti-monopoly, national security and other factors that your own upstream and downstream supply chain enterprises may be affected by.”
The prognosis of future changes in supply chain is particularly critical. Xie says general counsel need to carry out legal research, and prepare corresponding measures, in advance. Accepting the situation is the first step towards shaking off the downturn.
You Minjian, a Shanghai-based founding partner at Co-effort Law Firm, says: “In an age when all parts of society are interconnected, one part may be affected by the failure of another seemingly unconnected part. Therefore, realizing the importance of these connections is of great value.”
HIDDEN IN THE CLOUD
With most countries persisting with lockdowns and restrictions on movement, remote working has become the choice of many enterprises. Videoconferencing and the use of location data to clock in have become the norm for businesses seeking to reopen. While remote working may seem like a panacea, it comes with its own challenges and risks.
Sun Bin, general counsel at Xiaomi Corporation, points out that, compared with working in an office, remote working makes it difficult to sign and seal relevant legal documents, which brings new challenges for in-house counsel. For enterprises with overseas operations where laws and regulations are frequently being updated, Sun says in-house counsel should pay close attention to assisting in setting up an online presence to meet the demands of the business.
Despite the efficiencies that remote working brings, Ma says in-house counsel should be especially concerned about compliance standards in data security and privacy policies. For example, in the effort to prevent and control the spread of the pandemic, many enterprises collected all kinds of information from employees to comply with government diktats. But what should enterprises do with all this data after employees return to offices?
Calvin Chiu, a Beijing-based counsel at Dentons, warns against personal data misuse. “When the pandemic is over, businesses must not continue to use personal data for other purposes, for example, using location data to monitor their employees,” he says.
“Cloud offices could mean a more intrusive means to monitor and assess employees’ performance. Any behavioural monitoring should be conducted in a transparent manner.”
With regard to communications, the Washington Post has reported that thousands of corporate videoconferences are unencrypted and can be viewed on open platforms, including corporate meetings involving personal identity information and company financial statements.
Ian Wang, a partner at DeHeng Law Offices in Beijing, suggests that enterprises may examine their practices and adopt the following: (1) According to the confidentiality of the meeting, select videoconference software with high-security performance that suits the enterprise; (2) Strengthen security verification. Before the conference, participants should be carefully checked to ensure that accurate information is sent to them. During the meeting, strictly check the participants and remove unknown persons promptly; (3) Check the source link. Employees should also pay attention to confirming whether the source link of the conference is reliable, or whether it is malicious – with an extension such as “.exe”, which carries significant security hazards – when they receive a conference invitation; and (4) Install the latest patches provided by service providers and timely update the software.
“Enterprises can purchase cybersecurity insurance if possible, and transfer the risks caused by cybersecurity incidents,” he adds.
For other third-party platforms or tools used in a cloud office, ordinary users tend to ignore the service agreement prior to launching them.
You, of Co-effort, says: “[Enterprises] in particular need to be fully aware of the permission they grant to the service provider to store, use and dispose of their user data, whether the data will be encrypted, and what kind of responsibility [the service provider] will bear if leaks occur.”
For confidential matters, You suggests that no public transmission of highly confidential information should be carried out, watermarks or passwords should be added to relevant documents, and confidentiality obligations and codes should be emphasised to employees.
A report issued by the representative office of the UN Development Programme in China, assessing the impact of COVID-19 on Chinese enterprises, says that tourism and catering industries are the most severely affected in the tertiary sector. According to the China Tourism Academy’s estimation, the volume of domestic tourists is expected to shrink by 56% and 15.5%, in the first quarter of 2020 and the full year, respectively.
For the tourism industry, Ma, from Tongcheng, points out that the suspension of travel has meant that the business and income of enterprises has been sharply reduced. Enterprises are facing a crisis of survival. “The suspension of business involves a large number of order returns and loss allocation issues,” she says.
Sun, of Xiaomi, suggests that in-house counsel should “provide more active and efficient legal support, and participate in the drafting and negotiation of agreements arising from changes in business requirements in a timely manner, in order to steer above the development of the pandemic”.
The China Council for the Promotion of International Trade (CCPIT) has introduced a map of overseas pandemic control measures on its website, which can serve as a reference in examining a specific country and evaluating the risks in contract performance. The map categorizes attitudes towards trade in goods/medical supplies, inbound and outbound transport, frontier ports, entry of personnel, emergency situations and so on under each country.
Force majeure. For some domestic contracts, unexpected situations caused by lockdowns, shutdowns and even traffic control have meant difficulties in performance. “The Commission of Legislative Affairs of the National People’s Congress and the Supreme People’s Court have confirmed that COVID-19 constitutes force majeure, which establishes the basis for handling the affected domestic contracts,” notes You.
As for international contracts, “although the CCPIT has indicated that it can issue force majeure certificates for enterprises, what role this certificate will play in international dispute resolution remains to be tested,” he says. “Enterprises engaged in international trade may pay attention to relevant judgments or tendentious opinions made by international arbitration institutions on COVID-19.” (For a discussion on force majeure in different jurisdictions, see this issue’s Lexicon article, Pandemics, on page 121).
INVESTMENT AND FINANCING
Cash flow is the foundation of business operations, and Xie, of Foxconn, says that from February onwards, both direct and indirect financing has been relatively active under the pandemic. “Financing involves risk management, thus general counsel need to carefully handle the legal risks in the process of borrowing, issuing bonds and stocks and so on,” he says.
For enterprises with a low asset-liability ratio and abundant cash flow, Xie suggests that, in the later stages of the pandemic, they may consider investment and M&A. “Due to the influence of the pandemic, both at home and abroad, the uncertainty and risks in M&A are far higher. Some factors must be fully assessed, such as the adjustment mechanism for the valuation of the target enterprise, the stability of the market and earnings, the design of default clauses, covenants and warranties in related agreements, etc.”
Risk allocation is central to contract construction, and Chiu, of Dentons, advises that in setting up default clauses, parties may refer to the following principles: (1) consider carefully how to limit the grounds on which a party may withdraw from the transaction to facilitate and consummate the deal; (2) increase the granularity of the breach of contract and damages clause, to ensure that they can apply to the most probable situations; and (3) follow the fairness principle to avoid drastic consequences or windfall gain to either party.
SMES HIT HARD
For small and medium-sized enterprises (SMEs), the pandemic has been particularly severe. Fu Xiye, general secretary of the legal advisory committee at the China Association of Small and Medium Enterprises, and a senior partner at DHH Law Firm, says that the main issues faced by SMEs include: shareholders’ failure to pay their subscription capital on time, resulting in operation difficulties; being sued for arrearage and assets being seized; laying off staff for lack of orders; and even going bankrupt. Fu suggests that SMEs “negotiate on friendly terms with the relevant parties to seek financial or market support”.
Government involvement may be the greatest hope for SMEs to get out of a bad predicament. You, who participated in public welfare legal services during the pandemic, says that the two major problems faced by SMEs are labour and contract performance, which have already been greatly alleviated with the introduction of guidance documents from the government.
Having dealt with the Severe Acute Respiratory Syndrome (SARS) outbreak in the past, Quan, from ETR, says the administrative organs of Guangdong province reacted quickly to help SMEs deal with COVID-19. For example, the local government immediately decided to exempt three-month contributions on mandatory social insurance and housing provident fund payments for micro and small enterprises.
Maintaining corporate image is not the traditional function of a legal department, but with the evolution of internet platforms, the relationship between legal and PR departments is becoming closer.
“Along with the pandemic, negative reports and even rumours have spread rapidly in the media,” Xie says. “General counsel need to work closely with their company’s PR department so as to respond quickly and accurately and stop the spread of rumours.”
Ma, who also senses the pressure coming from public opinion, says that dealing with this situation “requires closer, frequent and efficient cross-sectoral communication and co-operation”.
KEEP CALM, CARRY ON
Globally, neither a vaccine nor a wonder drug has yet been invented, and it is likely that the pandemic may last for a good deal longer. So, under strict prevention and control measures, how should enterprises deal with the “new normal”?
“Enterprises need to adjust working style, business strategies and direction of development to adapt to a future where the social and economic environment may remain under the long-term impact of the pandemic,” says You.
Xie suggests that enterprises should take the initiative to adjust their geographical layout of development. “Many enterprises set out years ago to transform themselves into global citizens to cope with risks in the supply chain,” he says. “Greenfield investment is one of the top choices. General counsel need to do a lot of preparation to help business and operation departments achieve commercial success.”
However, legal departments are set up for managing risks for enterprises, Xie points out, and risk events occur every year, to varying degrees. “As a general counsel, prudent and calm responses should suffice,” he says.