More U.S.-China film deals may fall through for lack of funding

Chinese film executives agree it’s getting harder to get money out of China

Tax authorities have looked the other way at gray-area practices but are unlikely to continue doing so

The 40th Annual UCLA Entertainment Symposium took place this past weekend, and in recognition of the Chinese film market’s meteoric expansion, the symposium for the first time devoted an entire panel to China. The panel featured three high-powered Chinese film execs: Eric Rong, President of TIK Films, Jay Sun, Chairman and President of Pegasus Media Group, and Simon Sun, Executive Vice President of Le Vision Pictures (USA).The panelists were uniformly positive about the future of U.S.-China film cooperation and mutual investment, but the most interesting exchange (to me) was when they addressed the question of Chinese currency restrictions.

The panelists agreed that getting money out of China was difficult and becoming more so, and commented on two general solutions. First, Chinese companies with substantial cash reserves in China can set up a credit facility with an international bank with a U.S. presence; Rong said that this is what TIK Films’ parent company Hunan TV did with East West Bank (e.g., to finance its big deal with Lionsgate). Second, Chinese companies can set up a Hong Kong company and send money from that company, as Hong Kong Dollars are freely convertible; this is what Pegasus does, according to Jay Sun.

These solutions are sophisticated, appropriate and (not surprisingly) in line with how we often advise our entertainment (and other) clients. A word of caution, though: these approaches will only work as long as the Chinese government allows them to work. Yes, Hong Kong doesn’t have currency restrictions, but companies still need to get the money to Hong Kong in the first place, and that technically requires pretty much the same approvals as sending money to the U.S. directly.

Alternately, Chinese companies can get money to their Hong Kong company by requiring that customers send payments to Hong Kong for goods or services provided in China. This is perfectly acceptable—so long as the Chinese companies have secured prior Chinese government approval for the Hong Kong bank account and so long as they report and pay taxes on such payments. I think you can guess how often that happens. The Chinese tax authorities haven’t been overly assiduous about enforcing these restrictions over the past several years, but I would be surprised if that didn’t start to change.

Just to give you an idea of how commonly these Hong Kong bank accounts are set up legally, many years ago we represented a very large publicly traded U.S. company that had just bought a wholly foreign-owned enterprise (WFOE) in China. All of the 20 or so suppliers to the China WFOE’s suppliers were getting paid in Hong Kong. Our client did not like that due to concerns that it might be seen as facilitating tax evasion. So it requested that the 20 suppliers provide proof that their Hong Kong bank accounts had Chinese government approval. We got the following responses from those Chinese companies:

Are you kidding? Everybody does this. Probably four to five said this.

Are you kidding? No way. Probably four to five said this.

Another four to five sent us documents that they thought we would believe were Chinese government documents allowing them to open a bank account in Hong Kong, but they were not.

The remainder just ignored our request for months.

Most importantly, not a single one of them could produce legitimate proof that their Hong Kong bank account was legal.

Another common method of converting RMB to dollars (not mentioned by the panelists because it isn’t relevant to the financing of major studio films) is the “exception” that allows each Chinese individual to send $50,000 overseas each year. Wealthy Chinese individuals seeking to fund a movie or Broadway show, purchase real estate, or invest in an EB-5 project have taken advantage of this loophole by recruiting a gaggle of people in China to send money on their behalf. This process, known as “smurfing,” has been widely used for years. I’ve met multiple people at the U.S.-China Film Summit who proudly told me their entire business model was based on facilitating these payments. At dinner the other night, an acquaintance told me about a Chinese factory owner he knew who had required 200 of his employees to send $50,000 each to the United States. But smurfing is legally questionable and the Chinese government is cracking down on this practice as well. As my colleague Steve Dickinson observed in a recent interview with Bloomberg Business, banks are sometimes refusing such transactions by saying they simply don’t have any dollars available.

Long story short, we can expect to see more U.S.-China film deals fall through for lack of funding, and it won’t necessarily be the fault of the Chinese company. Simon Sun referred to a piece in the Los Angeles Times last year (presumably this one) about the large number of U.S.-China deals that had been cancelled because the money never came through. Sun stated that the article was true, but biased – deals have been falling through as long as Hollywood existed – because the legitimate Chinese companies are real (and have real money). I couldn’t agree more. But it’s often hard to tell who’s for real, which makes both due diligence and the way the deal is structured more important than ever.

—A version of this article was first published on the China Law Blog.