China Contracts, But With Whom?

One of the most important things to determine before entering into a contract with a Chinese company is to make sure that you are contracting with the right company The right company is usually the company with sufficient financial resources to cover you if and when things go bad. On one level this sounds incredibly obvious, but I can tell you that foreign companies get this wrong all the time.

This seemingly simple principle is often overlooked because many U.S. buyers of products manufactured in China contract with third-party sourcing companies unaffiliated with the Chinese company that actually owns the factory making the product. So when a product defect is uncovered, the U.S. buyer will only have legal recourse against the sourcing company with whom it contracted and not the actual Chinese manufacturer.

Oftentimes the foreign company will contract with the Chinese manufacturer’s holding company in Hong Kong, Taiwan or Singapore. Like the typical sourcing company, these sorts of holding companies rarely have assets much beyond a few computers and a market-rate office lease.

Before contracting with anyone, you should do your due diligence and make sure the party you are paying is not a shell entity or a sourcing company with little or no assets. When the contracting party is the U.S. sales subsidiary of a Chinese contract manufacturer, you should consider having the Chinese contract manufacturer co-sign the agreement or guarantee its performance.

The following are just some of the instances where American companies have gotten into big trouble by not abiding by the rules above:

• American company pays Chinese company nearly a million dollars to produce a toy line for it. Chinese company never produces a single toy. American company hires our firm to explore options for pursuing the Chinese toy manufacturer. We look at the Chinese language official version of the contract and the signing party is a completely different entity than the Chinese toy manufacturer with which our client believed it had contracted. A few hours of research reveals that the company with which it contracted was a one person “sourcing consultant” who operated out of a $300 a month single person office. Not good.

• Many years ago, an American company called us after just having learned that its two million dollar order of Christmas tree lights would not be delivered to the United States until December. We called the factory and they told us they had no idea who our client even was. It turned out that our client had unknowingly been using a sourcing agent (we figured it out by looking at some Chinese language documents) and so it had absolutely no contractual relationship with the factory. So at that point, all it could do was to beg its agent to do whatever he could to get the factory to speed up the order. There was no point in suing the agent because he was one guy in a small office with an old computer (we investigated).

• American company gets bad product from its Chinese clothing manufacturer and so refuses to pay the remaining $500,000 or so for the shipment. American company then gets sued in China and retains us to assist. Turns out that the lawsuit in China has been brought by a Chinese sourcing agent whose contract with our client makes clear that he gets paid for brokering each transaction, whether or not the transaction goes well or not. In other words, there would have been a very good chance that this sourcing person would have prevailed against our client because he had fulfilled all requirements of his deal with our client, and the fact that some third party manufacturer had provided bad product was irrelevant. Our client ended up settling.

We could go on and on.

The key to avoid these sorts of problems is to know your counter-party. The way to do that is to get the Chinese name of the party with which you will be contracting and then do your due diligence on that company. Generally (though not 100% of the time), the best party with which to contract will be the company that owns the factory that will be making your product or providing you with the contracted-for service.

Just get it right.

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We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.