China’s Stumbling Economy And You

I write a version of this post whenever China’s economy is slowing. Now is obviously the right time to reprise it. I was reminded of that fact this past weeks by an emails I received from an American company whose supplier had shut down, leaving this American company without its already-paid-for product.

Whenever the China lawyers at my law firm start getting an increasing number of emails from companies with “lost” orders from China suppliers that have shut down without providing ordered product, I write a post like this one, detailing what foreign companies doing business in China or with China should be focusing on to protect themselves. Those phone calls and emails started increasing a few months ago and I have always viewed these as a pretty decent indicator of what is happening to Chinese manufacturers and as a “call to arms” for foreign companies doing business in China to step up their China legal and due diligence game.

The emails we have been getting are like the following (which actually came to me during China’s last economic downturn, but does such a good job of setting out the situation that I am reprising it again for this downtown:

Hi. I am an avid reader of China Law Blog. I run a small _________ company in Shanghai and have come upon my own situation in which I would like to ask for a legal opinion. It’s not a very big issue and maybe not even worth pursuing it but since we are a very small company with limited funds it’s still of relevance for us.

A part of our business is renting out _________ machines to customers such as restaurants. One of these restaurants has just gone out of business. Since several months of rent are due to the landlord, the landlord has locked the shop down with all equipment (our _______ machine, the restaurant’s employees’ personal things, etc.) all still inside. The landlord is saying that they will release everything inside the restaurant only after discussing with the restaurant operators, all significant employees of which have now left town.

I am not exactly sure what will happen, the situation is vague as many things are here, but we would like to get our machine back (wholesale cost of about 20k RMB).

My questions now are if the landlord has the right to keep our property (e.g., the machine) and if not, if there is anything worthwhile that we can do about it?

Thank you.

Here was my response:

Without reviewing your contract with this restaurant, I have no way of knowing what you can and should do. If you have a really good contract (preferably in Chinese and chopped by the restaurant) that makes clear that the ______ machines belong to you unless and until they are fully paid-for, then you should show that to the landlord and the odds are good it will let you walk off with your machines. If you don’t have such a contract, I wish you good luck because at that point it is not likely to be very clear who owns what.

This is China’s new reality, brought about by more China businesses failing.

When Chinese manufacturers go under and a fight over the manufacturer’s assets ensues, a foreign company with a good Chinese language contract making clear virtually always does much better in the asset fight than the foreign company that bought product using just a PO (purchase order).

During China’s last economic slowdown in 2012, I wrote a piece for the Wall Street Journal discussing the impact China’s slowing economy is having on American businesses that do business with China and how they should respond to that. The article is entitled, China’s Slowdown and You. If you want to read the whole article, you should Google this title and “Dan Harris” and then click the leading link and the full article will appear.

In that article, I asserted the following:

• The Chinese government “is more concerned with social harmony than with economic numbers” and that is why it is continuing to encourage wage growth even though higher wages make China’s factories less competitive.

• China’s prioritization of its citizens’ contentment means that China is going to get tougher on foreigners, just as it (and nearly every other country) has always done when times are tough. Everything foreign businesses do will be under heightened scrutiny.

• The authorities are throwing new roadblocks in the way of foreigners seeking to form businesses in China. Such higher standards are not uniformly applied. Beijing and local governments are ever more eager to distinguish between “contributing” and “noncontributing” foreigners. Thus, it has never been easier for well-funded, nonpolluting foreign companies to secure approval to operate in China. Conversely, it has never been tougher for foreign companies that pollute, pay low wages, or have no plans to hire Chinese employees to get their foot in the door.

• Chinese exporters, particularly those that compete with companies from lower-wage countries like Vietnam and Bangladesh, are suffering —in particular in very low-tech, very low-wage industries such as textiles, clothing, shoes and low-end electronics and toys. Foreign companies that do business with Chinese companies in these industries must be on their guard.

• The key to weathering China’s slowdown will be for foreign companies to go back to basics: think afresh about what your company contributes to China’s economy and how that is likely to shape policy makers’ opinions; focus on scrupulous regulatory compliance; and renew your focus on due diligence at a company-to-company level.

“Though the above is happening, there is something very positive in China is happening as well: a greater number of China businesses are getting savvier, more sophisticated and more international. China’s high end companies are getting bigger and deeper at the very same time its low end companies are suffering. These high end companies are doing their utmost to do more than just churn out bad quality widgets; their goal is to provide a product or a service (or a product and a service) that can compete anywhere. [We first started talking about this trend in 2012] and since then I have mentioned it at just about all of my speaking engagements and I am finding that people are increasingly agreeing with me on this. The point is not that the existence of such Chinese companies is new, rather that the number of them is proliferating at a rapid pace as more and more Chinese companies are realizing that “stepping up the pace” is the best way for them to survive. Co-blogger Steve Dickinson hit on this trend in his post The New Role Of Written Contracts For Product Purchases In China.

In other words, the importance of choosing your China partner — which was always critical — has become even more so.”

China’s most recent economic “hiccup” has been a multi-edged sword for Chinese manufacturers. On the one hand, the Renminbi’s devaluation should actually improve the competitiveness of Chinese manufacturers that do not source a large amount of components from outside China. On the other hand, Chinese manufacturers are being cut off from funding sources and many that are not well capitalized are in trouble. It is this last element of this downturn that I find scariest, and again, our best advice is that you fully document your transactions and do your utmost to determine the financial wherewithal of your Chinese counter-parties before you pay. Nothing that I wrote the last time needs change for this latest version of China economic downturn.

Do you agree? What are you seeing out there? 

The post China’s Stumbling Economy And You appeared first on China Law Blog.

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.