Copyright Euromoney Institutional Investor PLC May 2007

 

China's large but fledgling legal service market has proved to be very attractive to foreign lawyers in recent years. According to research efforts by authors Charlie Xiaolin Wang and Xiaowei Chen, both experienced legal practitioners, Chinese law firms and foreign law firms play different roles in the legal service market in China. Foreign law firms have certain advantages over Chinese law firms, in such areas as experience, specialization and management. But local firms also have an edge over their foreign counterparts in other areas such as cultural understanding and business networks. So who is taking the lead and where do these firms fit into the big picture.

By Xiaowei Chen, Beijing Chang An Law Firm 1 and Charlie Xiaolin Wang, Wang & Nance 2

The number of legal services organizations in China totals approximately 51,000 offices, consisting of law offices, notarization offices, patent proxy offices, trademark proxy offices, copyright proxy office, grass-roots legal service offices as well as social legal consultation organizations, with about 450,000 practitioners. Among them, there are 12,428 law firms. They account for 24.3% of the total social legal service organizations. According to data disclosed in Legal Daily dated January 22 2007 3, there were 169 overseas law firms and 72 Hong Kong law firms in China, which make up approximately 1.9% of all law firms in China.

In July 2006, the All China Lawyers Association announced that the number of legal practitioners in China had reached 153,846, with 114,471 full-time lawyers, 7,418 part-time lawyers, and 31,957 legal assistants. More than 70% of the certified lawyers have a bachelor's degree, while over 15,000 also have a master's or doctorate degree. With a population of over 1.3 billion, China has one lawyer for every 8,544 people.

Chinese law firms and Chinese lawyers are major participants in the legal services market in China. However, with the globalization of trade, finance and investment, overseas law firms and their representatives have gained a foothold in China's legal services market.

Legal services work has extended from traditional lawsuits and civil representation of parties in court to new fields like finance, securities, futures trading, corporate mergers and acquisitions, the IT industry, and others. Legal services are diversifying and becoming more important for the implementation of national laws, safeguarding the public's legitimate rights and interests, stabilizing social order, maintaining and protecting fair market practices, and regulating activities in capital markets.

With the reform and opening up of the Chinese market as a whole, China's legal services industry has gradually entered the international market. Globalization and liberalization of legal services will be central to the development of China's legal services industry.

CHINA'S LEGAL SERVICES MARKET

Market Scale

Table 1 below shows that the proportion of legal services revenue to GDP in China is much lower than that in the USA. This reflects the gap that remains between China and more developed countries. However, it also shows that legal services in China have great development potential.

In addition, the growth in Chinese legal services revenues from 2003 to 2005 shows that China's legal services industry is developing rapidly, with a compound annual growth rate of 50.29%. With the continued development of the Chinese economy and the opening up of China's services industry, the revenues of the legal services industry should continue to grow rapidly in the future.

China currently has over 210,000 judges, more than 160,000 procurators, over 120,000 certified lawyers and 12,000 certified notaries. Since the introduction of a national judicial examination system in 2002, an average of nearly 20,000 people have attained certificates to engage in legal careers each year.

Market Structure

In general, lawsuits, the main business in the Chinese legal services market at present, take up 75% of the market as a whole 4. Other practice areas, such as real-estate, securities, intellectual property, arbitration and M&A, are relatively mature. Meanwhile, some non-litigation business such as foreign investment, international trade, overseas initial public offerings and overseas M&As are being given more and more attention by law firms.

The Chinese legal services market can be classified into three market levels: the low-end market - dealing with various legal needs and disputes in the domestic market; the middle market - typically legal services that resolve disputes between domestic and foreign people; and the high-end market - legal services related to international capital, such as international project cooperation, investment and financing, overseas IPOs, multinational M&As, and other such deals. International law firms have rich experience in the high-end market, and have an obvious advantage in this field.

Regional Markets

The development of China's legal service industry has geographically followed the development of the Chinese economy. The most developed areas for legal services are mainly Beijing, Shanghai, Guangzhou, and Shenzhen. The total income for legal services in Beijing was about

Rmb7 billion in 2006, and the top-earning firm for the city had an income of Rmb360 million for the year. The income in Shanghai was about

Rmb3 billion in 2006 and the top office earned more than Rmb150 million in 2005. The annual business income of lawyers in Guangdong for 2005 was approximately Rmb2 billion, while that of Shenzhen alone was Rmb1.6 billion in 2006.

Beijing's Legal Services Market

By the end of 2006, Beijing had 984 legal institutions and 13,511 certified public lawyers altogether. It was disclosed by the Beijing Municipal Judicial Bureau that in 2004, the annual business volume of law firms in Beijing had reached 150 thousand cases, with a total income of Rmb5 billion for China as a whole (including local, foreign and Hong Kong law firms) and a total tax payment of Rmb454 million. Foreign and Hong Kong law firms in Beijing brought in a total of Rmb 810 million. The income of Beijing law firms exceeded 1% of Beijing's GDP for the first time. By this time, legal business had already become an important industry in Beijing.

Table 2: Beijing Legal Business Income 2002-2006

Shanghai's Legal Service Market

As of February 2007, 750 law firms have been established in Shanghai and there were more than 8,000 certified public lawyers. Some of them are large-scale, full-service firms, such as AllBright Law Offices, Jin Mao Law Firm, Llinks Law Offices, Fangda Partners, Duan and Duan and City Development Law Firm. Many of these firms employ more than 100 lawyers. AllBright Law Offices, for example, has about 220 certified lawyers and 80 specialists and paralegals in between its Shanghai headquarters, Beijing branch, Shenzhen branch and Hangzhou branch. Some have handled deals of over Rmb100 million. Meanwhile, more and more foreign law firms are competing for the Shanghai market.

Table 3: Shanghai Legal Business Income 2002-2006

Guangdong's Legal Services Market

By 2006, there were more than 1,200 law firms and over 13,000 lawyers in Guangdong province. The annual business income of Guangdong law firms in 2005 was approximately Rmb2 billion, and accounted for 0.2% of Guangdong gross domestic product. The development of the legal services market in Guangdong province has happened at different speeds among cities and regions. For example, in 2005, the annual business income of Shenzhen law firms was Rmb1.37 billion, and the per capita income of Shenzhen lawyers was Rmb390,000. By contrast, there are some developing regions where people have difficulty making money from litigation. 70% of Guangdong lawyers work in big cities, particularly Guangzhou and Shenzhen. The development of the legal field is restricted by local economic conditions in smaller towns and counties, which have comparatively low economic development and a scarcity of legal practitioners.

International Law Firms Entering the Chinese Market

At the beginning of 2007, there were 169 overseas law firms and 72 Hong Kong law firms in China, which approximately took up 1.9% of all law firms in China. 5 The largest and most profitable international law firms have entered the legal service market of the Chinese mainland one after the other, mainly setting up in Beijing, Shanghai, Guangzhou and Shenzhen, and the circle of Chinese lawyers faces fierce competition with foreign lawyers.

THE IMPACT OF FOREIGN LAW FIRMS

Background

China began setting up office pilots for foreign and Hong Kong law firms in mainland China in 1992. The Department of Justice and the State Administration for Industry and Commerce published the Interim Provisions of the Ministry of Justice, the State Administration for Industry and Commerce on the Establishment of Offices within the territory of China by Foreign Law Firms. The Chinese market was officially opened to the outside world shortly afterwards.

In 2003, China abolished the "Three Restrictions" on the legal services market. This eliminated restrictions on the total number of offices established in China by foreign law firms, the limit on which cities foreign law firms could establish offices in, and the policy of only allowing one office per foreign law firm. Consequently, many well-known law firms established offices in both Beijing and Shanghai, accelerating the development of legal services in China.

The Chinese government continues to fulfill its commitments to WTO rules by further opening China's legal services market, which is a rather favorable policy for the legal services market. The political stability of China is also helpful for the business development of foreign law firms.

Advantages of Foreign Firms

China's rapid development has attracted the attention of the world. Foreign investment, mergers and acquisitions by multinational corporations, international trade, Chinese companies' overseas acquisitions and overseas IPOs involve complicated legal issues. International law firms have rich business experience in these fields.

The annual turnover of large international law firms can exceed

US$1 billion. They own branches all over the world, and employ thousands of excellent lawyers. Adequate funds and strong teams lay a solid foundation for these law firms.

The specialization, advanced management and branding of foreign law firms are advantages that Chinese law firms cannot match. These are all important competencies for success in the Chinese market, and have served them well.

Political Challenges

The opening of the legal services market is an inevitable requirement for China's economic globalization, and is an important reflection of trade liberalization. As a specialized professional service, though, it has been strictly regulated by domestic policies in every country. For example, many countries don't permit foreign lawyers to interpret their laws or write legal opinions on applying the laws of these countries. Most countries, however, are now trying to open up their legal services markets.

Cultural Challenges

For international law firms, different working cultures, legal environments and local customs pose challenges in many legal and business service fields. For example, when an overseas law firm provides legal services to a domestic enterprise, especially in the case of state-owned enterprises, it can be difficult to understand the business culture or working style of the client. The language barrier is another factor that cannot be neglected. Domestic law firms can more easily communicate with relevant authorities, such as the China Securities Regulatory Commission, the National Development and Reform Commission, or the Industry and Commerce Administration. Although some Chinese paralegals are employed by overseas law firms, and some associates graduating from overseas law schools are also Chinese nationals, most lawyers employed by international law firms are foreign lawyers with little or no knowledge of the Chinese language. Some legal research work can be done by Chinese paralegals, such as consulting the Ministry of Commerce on certain legal issues, but the language barrier does indeed restrict international law firms from expanding their business in China.

Human Resources

In terms of scale, localization and business scope, it is difficult to compare local and foreign law firms. For international firms, localization is the key to further development. To achieve localization, they must realize the importance of local business and recruit Chinese partners to help develop their business in China. Subject to Chinese regulations regarding foreign law firms in China 6, a Chinese certified lawyer can't be taken as a partner of a representative office of an international law firm in China and remain locally qualified. According to regulations, lawyers wishing to remain locally qualified shall not be taken as a staff of foreign law firm. Because of this, Chinese lawyers working in foreign law firms are not formal members of the foreign law firm. The style of cooperation is and must be loose. Most cooperation involves engaging an experienced Chinese lawyer as a senior legal consultant to an international law firm. For example, Robertson Stromberg Pedersen of Canada has established a strategic cooperative relationship with Winners Law Firm in Tianjin, and Xu Yongge became a legal consultant on Chinese law for Robertson Stromberg Pedersen. 7

Long-term Developments

Foreign law firms must face the strict scrutiny of the Department of Justice before they enter the Chinese market. China is one of the most dynamic markets in the world, and many foreign law firms are eager to step into it. Large quantities of applications leads to intense competition. For example, in 1993, the Chinese government announced that not more than 40 foreign law firms would be approved to start businesses in China. At that time, several hundred foreign law firms were applying to enter the Chinese market. Although at present the quantity of approved foreign law firms is more than 160 (excluding Hong Kong law firms), the number of foreign law firms hoping to enter the China legal services market is still increasing. 8

Some of the biggest clients of foreign law firms tend to be Chinese subsidiaries of well-known multinational enterprises. Expanding their list of clients to include state-owned enterprises, with intent to carry out mergers, acquisitions and direct or indirect investment overseas, is an important task for these firms. State-owned enterprises have always had complicated decision-making procedures, and foreign law firms need to adapt to these working styles. Costs are another important factor that these clients consider. As time passes, more and more Chinese enterprises will have the financial ability to pay for legal services from foreign law firms.

Other Factors

Foreign law firms also have difficulty with public relations in China, which is an area in which they cannot be compared with their Chinese counterparts. Their difficulty in understanding China's national conditions is also one of their disadvantages. Any economic organization will face the problem of localization when it operates internationally. When a foreign law firm enters China, it will need to acknowledge and adapt to Chinese trade customs and cultural norms.

The WTO granted an exception to its members on legal market access; that is, the legal services relating to national justice will exclude the entry of other foreign peers. This practice will avoid the participation of international law firms in the legal services relating to justice, such as litigation, notarization concerning justice and other legal services concerning justice. 9 In other words, foreign law firms are prohibited from attending litigation, interpreting Chinese laws or issuing legal opinions on Chinese legal affairs. This enormously restricts the business scope of international law firms in China.

MARKET STRATEGIES

Localization of Talent

Market competition is actually a competition of talent. Law firms cannot be strong without high-quality lawyers. In September 2002, Morrison & Foerster beat Coudert Brothers in the bidding for legal services for the Olympic Games 2008, and was appointed as the international legal counsel of the Beijing Organizing Committee for the Games of the XXIX Olympiad. This is closely related to the localization of talent strategy it adopted. Having hired Beijing partner Steven L. Toronto and Hong Kong partner Venantius Tan from Coudert Brothers, Morrison & Foerster greatly expanded its business in China. 10

There are now large numbers of Chinese lawyers who grew up in China and have studied abroad. Generally speaking, they tend to do their undergraduate education in China before going abroad, and receive LLM, JD or SJD degrees from overseas law schools. Some gain working experience in prominent law firms in the country in which they studied. They know and understand the politics, economy and legal environment of China, and are very proficient in foreign languages, making them very popular recruits for foreign law firms. Currently foreign law firms lure such talent chiefly by following means.

Brand - relying on brand advantage, foreign law firms can gain many multinational clients, which gives lawyers exposure to important international commercial transactions and cases that quickly raise their level of competency.

High salaries - foreign law firms employ graduates from mainland law schools with a salary of Rmb6,000-8,000 per month for the first year, and multiply their salary in the second or third year. Such lawyers with two to three years of professional work experience and a good level of English can receive an annual salary of Rmb200,000-350,000, while in most Chinese law firms, monthly salary is only Rmb1,000-3,000 for the first year. In some prominent domestic law firms however, monthly salaries can reach Rmb5,000-7,000 for the first year.

Training - some international law firms will scout for talent from Chinese law firms and law schools and give them adequate training. US law firms such as O'Melveny & Myers and Jones Day have established scholarships in colleges and universities in Shanghai and Beijing. The winning students not only can receive monetary rewards, but also gain access to tutorship by the firms' lawyers. Also, Chinese lawyers who have a certain number of years' work experience will have opportunities to accept training abroad.

Beneficial Cooperation between Chinese and Foreign Law Firms

Chinese and foreign law firms have tremendous potential for mutually cooperative relationships. Compared with Chinese law firms, foreign law firms have certain disadvantages, as mentioned previously. They do not have close relationships with Chinese local governments and Chinese enterprises. But they do have operating experience and institutional support in transnational financing, which helps with mergers & acquisitions and international trade. Already, many leading domestic law firms such as Jun He Law Offices, King & Wood, Zhong Lun Law Firm, Llinks Law Offices, AllBright Law Offices and others have had successful cooperative relationships with foreign law firms.

Foreign and Chinese law firms usually cooperate in large M&A deals and transnational affairs. In such cases, foreign law firms take charge of reviewing whether or not the transaction complies with international standards, while Chinese law firms review the transaction in terms of compliance with Chinese laws and regulations. Foreign law firms can also offer general consultations about China to foreign investors. Chinese law firms also provide their clients with consultation services on Chinese legal affairs in relation to international business. For example, when ACE group held shares of Huatai Insurance in 2002, O'Melveny & Myers invited King & Wood's Shanghai office as its partner to deal with the case. In fields such as anti-dumping and transnational dealings, where foreign law firms have an obvious advantage, Chinese law firms will often seek to cooperate with their foreign counterparts.

Strategies for Different Market Segments

As foreign investment continues to pour into the Chinese market, foreign law firms have entered the Chinese legal services market to provide high-end, non-litigation services related to foreign capital. The next step is naturally to serve both Chinese and international enterprises, competing for high-end clients with local firms.

Foreign law firms have a broad service scope, including investment, finance & insurance, mergers & acquisitions, overseas listings, asset securitization, foreign litigation & arbitration, office establishment, international trade, technology transfer, real estate, and intellectual property. Foreign law firms can choose a market segment as a way to enter the Chinese market. Compared with foreign law firms, local law firms also can supply such legal services other than litigation. As China has a shorter history of legal professional development, the practice experience of local law firms is not as great as that of foreign law firms, especially in the fields of foreign direct investment, M&A, asset securitization, and legal affairs related to the World Trade Organization.

MARKET TRENDS FOR LEGAL SERVICES IN CHINA

In the next two to three years, large international law firms will retain footholds in the high-end market, providing legal services for international project cooperation, investment and financing, general corporate work, mergers and acquisitions, and overseas listings. Other well-known international law firms that have not yet entered the Chinese market will be attracted by the growing economy to compete for middle and high-end markets.

Local Chinese law firms will continue to focus on general legal services related to solving various disputes for the local population, and for Chinese companies and people involved in foreign affairs. Litigation cases for smaller claims, handling mortgage procedures in purchasing homes, and legal consultations for small and medium enterprises will remain the territory of local firms, while some will penetrate the high-end market through cooperation with large international firms.

As shown in the graph opposite, according to the status of the development of the Chinese legal services market and the operational conditions of the Chinese economy over the past few years, it is predicted that this market will grow at a compound annual growth rate of 25.6% from 2006 to 2010, and reach an income level of over

US$6 billion by 2010.

Globalization and the liberalization of legal services is the trend for development in the legal services industry. In 2007, China will open its legal services market more deeply and broadly. 11 The legal services market in China will develop at a large scale and to a high degree, bringing more opportunities for both Chinese and foreign law firms.

Endnotes

1 Xiaowei Chen is a partner of Beijing Chang An Law Firm, with expertise in securitization, international trade and foreign investment in China. Chen obtained his LL.M. degree from Beijing University in 1996. Prior to joining Chang An, he was a professor at the Central University of Finance and Economics Law School. Chen has published various works in the field of corporate law, contract law, competition law and product quality law. He can be contacted at ryan9640@126.com. His thanks go to Zhang Kunyi and Zhan Hui for their intellect and efforts given to the essay.

2 Charlie Xiaolin Wang is the managing partner of Wang & Nance LLP, a boutique law firm in Washington, DC specializing in China-related legal matters. Before establishing his own law firm, Wang served three major US law firms. He was a partner of a preeminent Wall Street law firm and its chief representative in Beijing. Wang also teaches at Beijing University Law School and Tsinghua University Law School. He frequently publishes in the field of securitization and international trade law. He can be contacted at c.wang@ueico.net.

3 Aijun Liu, "Overseas Law Firms Enlarge in China, Lawyers in Mainland and Hong Kong Unite to Counterbalance", published in Legal Daily dated January 22 2007.

4 "Top Ten Issues in Lawyer Profession", China Economic Express Weekly 2003 No.38

5 Aijun Liu, "Overseas Law Firms Enlarge in China, Lawyers in Mainland and Hong Kong Unite to Counterbalance", published in Legal Daily dated January 22 2007

6 Article 16 of the Regulations on the Administration of Foreign Law Firms' Representative Offices in China: "A representative office shall not employ Chinese practicing lawyers".

7 Xiaofan Yang, First Tianjin Lawyer to Join Canadian Law Firm, February 2 2007

8 Jianwei Fang, "On Opening-up of Legal Service Industry after China Enters WTO", Administration and Law 2004 No.3

9 Article 15 of the Regulations on the Administration of Foreign Law Firms' Representative Offices in China: "A representative office and its representatives may only be engaged in the following activities that do not involve the affairs on Chinese law: (1) to provide the parties concerned with consultation in respect of the laws of the country where the lawyers in this foreign law firm are permitted to practice as lawyers, as well as consultation related to international treaties and international practices; (2) to be entrusted by the parties or Chinese law firms to handle legal affairs in the country where the lawyers in this foreign law firm are permitted to practice as lawyers; (3) to represent foreign parties to entrust Chinese law firms to handle the affairs on Chinese law; (4) to keep long-term contractual entrustment relationship with Chinese law firms to handle legal affairs; (5) to provide information on the influences to Chinese legal environment."

10 Yun Gao, "Analysis on Current Situation and Prospect of Foreign Law Firms in China", September 16 2003

11 When China entered the WTO, it promised a timetable for opening the service markets. The transitional period expired at the end of 2006, and many industries were fully opened. Global Agreement on Trade in Services also requests its members to open their domestic legal services markets gradually, to approbate foreign lawyer certificate, and to permit foreign lawyers to practice in the field of the host country's law after reasonable and fair examination.