It is becoming riskier for firms to conduct due diligence work in China. This is partly because China has recently expanded the broad counter-espionage law it introduced in 2014, called the “Espionage Law”. This makes it even more likely for individuals and corporations to fall foul of the law. It is also for policy reasons: China is even less tolerant of investigatory work, even where such work is done purely for commercial reasons.
The expansion to the Espionage Law will take effect in July of this year and warrants close attention as failure to comply can easily fall within the remit of criminal law. It is important to note that activities most European or American companies would consider normal commercial behaviour – i.e., investigating a counterparty prior to sealing a business deal – can, in many cases, offend the rules in China.
However, despite media coverage that implies this is all new, it is equally important to note that Chinese authorities have always had discretion to detain, or even arrest, people carrying out investigative due diligence. This has been happening on and off at least since the 1990s. The difference is that now the authorities seem even more inclined to exercise their powers.
Under the Espionage Law, prior to the expansion, espionage activities included “stealing, prying into, purchasing or illegally providing state secrets or intelligence” amongst other activities. Under this year’s expanded version of the law, this definition is widened to include “stealing, prying into, purchasing or illegally providing state secrets, intelligence, and other documents, data, materials, or items related to national security” amongst other activities.
In line with China’s usual practice, the law does not clearly define matters pertaining to “national security”. Nor does the law define “illegally providing”, “stealing”, “prying” or even “purchasing” means. This means that the provision essentially operates as a “catch all” clause which could result in wide-spread inadvertent infringement. There is the risk that simply carrying out due diligence in China on Chinese state-owned enterprises or other entities could qualify as espionage activities.
This is already happening: in March, local employees of the American legal and investigatory firm Mintz were detained in China and authorities closed the firm’s Beijing office. No comprehensible explanation was given. International press reported this as evidence of the operation of the new law, but in fact this crackdown happened before the new law came into force.
The reality is that Chinese law enforcement operates as dictated by policy rather than law. Laws merely show the direction policy is taking. In 2013, British corporate investigator, Peter Humphrey, and his American wife, Yu Yingzeng who operated a risk consultancy firm together were both convicted of illegally obtaining private information and sentenced to two years in prison.
Most analysts believe that the arrests were not part of law enforcement as it is generally understood in the UK, but were instead based on policy relating to a separate crackdown on the pharmaceutical company GSK.
In this series of articles we typically provide a checklist of do’s and don’ts. For due diligence in China, for obvious reasons we cannot do so, and would instead advise you to engage experts. Due diligence and investigation is the most important risk minimization work you can do with respect to a Chinese counterparty, and we do not advise skipping this vital stage in commercial procedure. Still less can we advise “going local” and relying on fixers or people with purported connections to solve your problems. There is, ultimately, no substitute for engaging experts.