Beijing, China – These days, available time is in even shorter supply than usual at the large Chinese law firm King & Wood, as its lawyers scramble to put in the necessary work to complete the firm’s merger with Australian powerhouse law firm Mallesons. Westerners, with good reason, have long criticised China’s quasi-closed system, but the rise of King & Wood may illuminate a long-term capacity-building strategy that appears to be paying off.
The existence of robust domestic law firms in China today appears to be the consequence of a protectionist strategy that has sacrificed the early full-bore introduction of elite legal services by Western competitors to build strong, sophisticated domestic firms. Now, Chinese law firms like King & Wood want to expand their growth outside of China’s borders, perhaps using future higher profits to attract better talent and thus building capacity and business on their own terms. However, this strategy that has proven effective for China may now serve as a constraint, an artificial ceiling on future growth.
Barriers to entry
Until the late 1980s, Chinese law firms were state-owned companies. All lawyers were state employees and paid by the state. Speaking on condition of anonymity, a senior lawyer in an American firm with offices in China notes, “There was very little FDI [foreign direct investment] at that time; trade activities mostly, negotiating licencing agreements”.
In 1992, the Chinese Ministry of Justice (MOJ) created regulations allowing a handful of foreign law firms from England, France, the US and Hong Kong to open “representative offices”. The lawyer says, “[American] lawyers were not authorised to practice Chinese law, but they may set up representative offices in China in order to advise American clients on American law of home jurisdiction.”
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Foreign law firms could provide “information” regarding China’s investment, economic and legal environment to their clients. The lawyer notes, “Practicing law involved going to court, so foreign law firms couldn’t do that. The question then and now is what is the middle ground between what is prohibited (practicing Chinese law) and what is allowed (providing information about China’s legal environment)? The distinction between these two is the issue – this is the so-called ‘Gray Area’.”
More importantly, individuals without Chinese citizenship are banned from taking the bar. This is so even if they speak Mandarin fluently and have degrees from Chinese universities. This regime exists in contrast to the US scheme, which allows anyone with any nationality to become a member of the bar in any US state so long as they attend a US JD or LLM programme and pass a US state’s bar exam.
Further, New York lets lawyers from common law countries take the bar upon approval of the student’s actual curriculum and California lets foreign lawyers sit as foreign lawyers for the bar as soon as three years after getting licenced abroad. Similarly, there are routes available in the UK, Germany and most Western countries for foreign lawyers to practice. Korea and Japan have implemented similarly restrictive services regimes as China, but they don’t scale like China does. They don’t have 1.3 billion people to leverage into the global economy.
What is the purpose of the non-citizenship ban and the Gray Area? Surely, China was and is worried about talented and deep-pocketed foreign law firms and foreign lawyers coming in and pushing human rights and rule of law reforms, but there was likely also an economic rationale for the competitive barrier: to give Chinese companies and domestic lawyers room to bloom.
Chinese ‘communist capitalism’
Many commentators like to think that China is communist only in name, but that narrative isn’t entirely true. China appears to use its “communist” philosophy as a stand-in for not only politics, but also economic nationalism – in other words, China engages in protectionist activities in order to give its weak homegrown companies and the largely mainland Chinese they employ, space to grow and build capacity without being outgunned by stronger foreign competitors from point zero.
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It’s China’s form of affirmative action – realising unequal starting points, China limits Westerners to a vitiated form of market penetration to enable its domestic companies to engage in know-how osmosis and for Western firms to provide some much-needed value-add for Chinese citizens and companies, while insulating domestic companies from the brutalities of market competition and creative destruction.
This strategy appears to have been effective. Instead of becoming subject to the full forces of capitalism, Chinese domestic law firms, given space to grow given the MOJ “Gray Area” and citizenship restrictions, have built enough capacity that they are aspiring to become global powerhouses, with the potential to compete with Western law firms at the international level.
Zhang Jianwei, a partner at the prominent Chinese law firm Jun He, notes:
Jun He was set up in 1989 and at that time, we had only five partners. After 23 years, Jun He now has more than 100 partners, in total more than 600 lawyers. Chinese law firms started to rapidly develop in the recent two decades.
The legal profession in foreign countries like the US and the UK have more than a hundred year’s history; they have a more mature legal service market. There was a large gap between [Chinese] domestic law firms and foreign law firms in scale and culture. Now, the gap on scales is gradually narrowing. Commercial litigation has been increasing rapidly.
Reasons [are] (1) [China’s] economic growth has sped up, with an increase in national and international transactions…(2) In China, the entire legal environment is changing… in recent years, the legal system has become more complete and a lot of laws have been passed, like the  Anti-Monopoly Law and the national security review system, which also create new legal services demand directly.
Zhang says that while in the past, Fortune 500 companies wishing to work in China tended to use Western law firms as liaisons, in recent years “the situation is gradually changing due to the development of [China’s] domestic law firms. Foreign corporations are starting to cooperate directly with domestic law firms who know the PRC laws and Chinese culture better”.
A prominent Chinese law firm, King & Wood (ironically having an Anglo name; its founders decided a Western name would be a better brand when the firm was created, given the dearth of Chinese law firms at the time – “King” and “Wood” do not refer to actual people), is merging with Australian law firm Mallesons, creating a transnational law firm that should have significant clout in the Asia-Pacific region and may augur the gradual expansion of Chinese firms beyond that region.
One could look at the King & Wood-Mallesons merger as the ideal outcome of China’s protectionist philosophy, whereby Chinese businesses continue to become more sophisticated on their own terms to the point where they are the ones engaging in entry into new markets. Zhang appears to share this sentiment:
We assume King & Wood has done a thorough analysis [of the costs and benefits of its merger with Mallesons]. It is time for every domestic law firm to think about the further development route if the firm [continues to develop]. It is not only a question of marketing; it is also about improving ourselves in full wave. There are so many things, like management, marketing development and risk control that we need to learn from the leading international law firms.
Chinese firms, insulated by the Gray Area and the non-citizenship ban, have attained significant capacity. However, they realise that they still lack the capacity to compete with the best international firms and so, Chinese firms may further increase know-how through M&A activity such as the King & Wood-Mallesons merger.
The barrier to Chinese entry
How the King & Wood-Mallesons merger plays out in terms of profits and book will dictate the effectiveness of Chinese law firm expansionary strategy going forward. There are potentially significant impediments to Chinese law firms conducting Western M&A beyond Australia – the latter is heavily economically reliant on China.
Riding China’s reforms to riches
Chinese laws may oblige Chinese lawyers to report information about their clients to the government, which would likely deter Western clients and Western law firms from sending over sensitive information and documents to Chinese law firms. Preston Torbert, a University of Chicago law lecturer and a lawyer with international law firm Baker & McKenzie, caveats the merger as regards the US context with the warning:
Foreign law firms have concerns about being affiliated directly with a Chinese firm and if the Chinese firm does something that is improper, then the consequences for the US firm could be very serious. To take one example, all US firms have malpractice insurance. Any kind of merger with a Chinese firm would be looked at very carefully by the insurers as to whether the malpractice insurance rates should be raised because the risk has increased because it’s very difficult to know what the experience of the Chinese law firms has been.
China’s restrictive and non-transparent legal system, a contributor to domestic capacity building, may also place a ceiling on future economic and capacity growth. In other words, China’s protectionist policy, while effective, has a sell-by date. Interestingly, it may be the economic pressures that led Deng Xiaoping to liberalise China’s markets that may lead the country to engage in legal reform.
King & Wood, Jun He and other Chinese law firms may find it difficult to continue to build capacity and grow otherwise, as Western M&A targets and clients may find a direct connection with China’s legal system to be too much of a risk.
China’s development strategy has managed to produce stronger and stronger domestic companies that are increasingly looking beyond Chinese and Asian borders for business and capacity building. Many commentators have predicted that this century will be a Chinese one. If that is to be so, it was not by mistake, but by design, and this strategy is perhaps one of the tools, along with straightforward economic, political and legal liberalisation reforms, other developing countries may consider using.
That being said, China should realise that its protectionist policy has been a contextual one, useful in the beginning when capacity is weak, but potentially self-inhibiting when capacity has grown and the desire for growth turns increasingly outward. If China truly wishes to continue its remarkable economic run, it would be well advised to realise when its outward restraints have become inward shackles, and to let the dragon fly freely.
Research Assistants Guo Yuhong and Wei Xuedan conducted interviews and research for this article. Professor Ray Campbell provided expert information for this article.
Michael Lwin is a lecturer at the Peking University School of Transnational Law.