China Law Blog - Harris Sliwoski LLP https://harris-sliwoski.com/chinalawblog/ Tough Markets, Bold Lawyers Mon, 25 Mar 2024 14:24:25 +0000 en-US hourly 1 https://wordpress.org/?v=6.4.3 https://harris-sliwoski.com/wp-content/uploads/cropped-Harris-Sliwoski-Logo-FinalIcon-White-1-32x32.png China Law Blog - Harris Sliwoski LLP https://harris-sliwoski.com/chinalawblog/ 32 32 How to Avoid China Manufacturing Problems: A Primer https://harris-sliwoski.com/chinalawblog/how-to-avoid-china-manufacturing-problems-a-primer/ Thu, 28 Mar 2024 10:58:15 +0000 https://harris-sliwoski.com/?post_type=chinalawblog&p=135440 China Manufacturing Problems are Increasing Imagine investing millions of dollars into a product launch, only to receive defective or unusable goods from your Chinese manufacturer – a scenario that could cripple your business. Unfortunately, this nightmare is increasingly becoming a reality for many companies that rely on China manufacturing, without proper safeguards. The increasingly tense

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China Manufacturing Problems are Increasing

Imagine investing millions of dollars into a product launch, only to receive defective or unusable goods from your Chinese manufacturer – a scenario that could cripple your business. Unfortunately, this nightmare is increasingly becoming a reality for many companies that rely on China manufacturing, without proper safeguards.

The increasingly tense geopolitical landscape, along with China’s economic slowdown, have increased the risks of manufacturing problems with Chinese manufacturers. This post aims to equip businesses with the knowledge and strategies to navigate the complexities of China manufacturing agreements to mitigate their risks and to ensure a seamless production process.

Our law firm’s international manufacturing lawyers have been seeing a big uptick in inquiries from companies encountering issues such as defective products or delayed shipments from their Chinese manufacturers. This trend reflects the broader challenges posed by increasing geopolitical tensions and China’s economic downturn.

The Solution to China Manufacturing Challenges: A Robust China-Centric Contract

Whatever the causes, having a China-specific manufacturing agreement is key to preventing problems when having your goods made in China. This post highlights what terms to prioritize in your China manufacturing agreement to avoid pitfalls from delivery delays to quality control problems.

The Importance of Having a China-Centric Manufacturing Agreement

Many of our clients who are now well-versed in China manufacturing learned the importance of detailed agreements through challenging experiences, having faced setbacks from overlooked contractual details or unforeseen manufacturing problems

We often write about the need to have a Chinese language Manufacturing Agreement with your Chinese manufacturer. In this post, we focus on what is truly important to include in that agreement, and even more importantly, the terms on which you should reach agreement with your Chinese manufacturer before you pay a lawyer to draft your agreement.

Though the simplicity of using generic manufacturing agreements or relying on verbal commitments might be appealing, the unique legal, business, and cultural landscape of China demands a specialized and meticulously drafted approach to avoid potential pitfalls. A China-specific manufacturing agreement is essential for several reasons. It addresses the nuances of China’s laws and regulations. It accounts for local business practices. It ensures that both parties clearly understand their rights and obligations. Most importantly, it gives you recourse should anything go wrong. This recourse both helps prevent problems and resolve problems that arise.

By investing in a well-drafted China-centric manufacturing agreement, you can establish a solid foundation for your manufacturing operations, while also minimizing the risk of misunderstandings and potential disputes down the line.

Beyond the legal and operational aspects, navigating the cultural differences between Western and Chinese business practices is a significant challenge. Effective communication is paramount, as misunderstandings can quickly escalate into costly conflicts. It is crucial to foster open and transparent dialogue with your Chinese manufacturing partners, ensuring that expectations are understood on both sides. Leveraging the expertise of experienced legal professionals can help you bridge the cultural and legal gaps, and facilitate a more harmonious and successful working relationship with your Chinese manufacturer. The foundation you establish with your manufacturing contract is key.

The Basic Requirements of a China-Specific Manufacturing Agreement

 

Contrary to popular belief, China’s legal system offers robust mechanisms for contract enforcement, outperforming not only common perceptions, but also the judicial systems of the United States, Canada, and the United Kingdom in efficiency. At least this is what the World Bank said in its last (2020) report ranking countries on their efficiency in enforcing contracts.

Yes, if you are seeking to protect your cutting-edge semiconductors based on a contract enforceable in China, your odds are not good. But if, on the other hand, you are seeking to enforce a run of the mill manufacturing contract or service contract and your contract was drafted with China in mind, you ought to be just fine.

The Five Keys to a China-Specific Contract

When drafting a manufacturing agreement in China, you should focus on the following five items to ensure that your contract is a China-specific contract that works for China.

Not having a comprehensive China-specific manufacturing agreement in place can expose you to severe risks, including:

  • Financial losses due to product defects, delivery delays, or non-compliance with quality standards.
  • Inability to seek legal recourse or compensation for damages.
  • Strained relationships with Chinese manufacturers, leading to potential disruptions in supply chain and production.
  • Reputational damage and loss of market opportunities.

1. China Dispute Resolution

Your contract with your Chinese manufacturer usually (but not always) should provide for disputes to be resolved in China, either in a Chinese court or before a China-based arbitral body, such as CIETAC.

China does not enforce most foreign court judgments, as highlighted in our post ‘China Enforces United States Judgment: This Changes Pretty Much Nothing.’ While China’s courts theoretically enforce foreign arbitral awards, the process is often complex and time-consuming. Therefore, it’s crucial to carefully consider the venue for dispute resolution.

China does not enforce most foreign court judgments, as highlighted in our post China Enforces United States Judgment: This Changes Pretty Much Nothing. Though China’s theoretically enforce foreign arbitral awards, the process is often complex and time-consuming. Therefore it’s critical to carefully consider the venue for your dispute resolution with your Chinese factory, and your best venue can depend on many things, including the nature of your contract, the situation of the Chinese company with which you are contracting, and your biggest risks.

2. Chinese as the Official Language

Designating Chinese as the official language of your contracts is not just a legal formality; it’s a strategic move that helps to ensure clarity as between you and your Chinese manufacturer, along with legal precision and enforceability in China’s judicial system.

If your contract will be in Chinese, your lawyer must fully understand the Chinese in your contract and China’s byzantine IP and manufacturing laws. They also should be fully capable of translating that contract into written English for you. Most of the contracts my law firm drafts with China are in both Chinese and in English, but with Chinese as the one official language of the contract. See Dual Language China Contracts: Don’t Get Fooled!

3. China Law as the Applicable Law

Your contract with Chinese companies typically should call for application of Chinese law. If your contract is in Chinese and your disputes will be resolved by a Chinese trier of fact, this only makes sense. Chinese laws on manufacturing do differ from those of the United States and the EU, but if you know what they are, it is relatively easy to contract in a way that protects your business.

One example I always cite is how there are no laws stopping your own manufacturer from duplicating YOUR product and selling it to ten other companies for 25% less than they are selling YOUR product to you. But, if your manufacturing agreement with your Chinese manufacturer prohibits this, your manufacturer selling your product to others will constitute a breach of contract for which you can collect damages. And if your contract also contains a commercially reasonable damages provision setting out what your Chinese manufacturer must pay you if it does sell your product to anyone else, the odds of your manufacturer selling your product to someone else just went way down.

4. Explicit Contract Damages

You usually should have a provision calling for contract damages. This provision can act as a heavy hammer against your Chinese counterparts. See China Contract Damages Done Right.

5. The Correct Chinese Company Name

Make certain the name (in Chinese) of your Chinese counterpart is 100% accurate and corresponds with its official company name. And while you are at it, it is also good to have your Chinese counterpart stamp/seal the contract as well. See China Company Chops: The Basics.

Fundamental Issues in China Manufacturing Agreements

When drafting a manufacturing agreement in China, you should focus on the following five key issues:

  1. Price
  2. Quantity
  3. Delivery date
  4. Quality
  5. Payment terms

Many manufacturing companies in China are small, privately owned businesses with limited funding, often using basic operational methods. It is not uncommon for a Chinese factory owner to tell us that since they gave our client “the China price,” and since that price is so low, it should not be required to care about the other four issues listed above — quantities, delivery dates, quality, and payment terms. When working with any China manufacturing company, you should make clear that all five of the fundamental manufacturing issues are critical, not just price. Only after you have resolved this with your Chinese factory should you move on to other more complex issues.

The below are some of the typical pitfalls our China manufacturing lawyers see companies make when negotiating price, quantity, delivery date, quality, and payment terms, with their Chinese manufacturer:

1.  Price

The product buyer negotiates a specific price list with its manufacturer, but the manufacturing agreement is written so that the Chinese manufacturer is not obligated to accept all purchase orders. So as soon as the agreed upon pricing works against the Chinese manufacturer, the Chinese manufacturer simply refuses to accept the purchase order and insists on a substantial price increase. When this happens in the middle of a sales season, it can destroy the product buyer’s business of the buyer. Our China attorneys get calls on this every year, not so coincidentally, especially as Christmas approaches.

2. Quantity

If your contract with your Chinese manufacturer does not include a penalty against your manufacturer for a short delivery, your manufacturer can make short deliveries with impunity, and they often do, especially if they have a new customer paying more for the same product. The best way to prevent short deliveries is to provide a penalty for short deliveries in your manufacturing contract, and to regularly monitor the production process in the Chinese factory.

3. Delivery Date

Many Chinese manufacturers view delivery dates on purchase orders as guidance, not a strict date. So long as the Chinese manufacturer delivers within two to three months of the delivery date, it feels it is doing just fine. This can of course be a disaster for the product buyer who has made delivery date promises to its own customers. The most common situation is a buyer purchasing for the holiday season. The delivery date is September 15, and the Chinese factory delivers on December 15. The Chinese factory says, “we were only three months late, what’s the problem?”

We had this situation once with a Christmas tree light company that contacted us in October after learning it would not be getting its two-million-dollar Christmas tree light order until December. Late deliveries can be particularly bad for foreign buyers who are feeding their product into a “just in time” inventory system. Late delivery means the whole system is affected, often subjecting the foreign buyer to crippling penalties.

A contract that is clear on the importance of delivery dates and has a damages/penalty provision to back it up, will greatly increase the odds of getting timely deliveries.

4. Quality

Quality problems from Chinese factories are well known. The below are just a tiny sample of the kinds of problems our China manufacturing lawyers have handled for product buying companies that retained us (for the first time) after problems arose:

a. Staples for an automatic nail gun. The staples were beautiful, except they did not fit into the product buyer’s nail gun.

b. Hand blown Christmas tree ornaments. A whole container arrived and on time. The objects were beautiful. The only problem was that the small ring required to hang the ornament from a tree was missing, making the entire shipment useless to the product buyer.

c. Etched glass fixtures installed between two sheets of glass in an argon filled custom window. Everything about the window was perfect, except that when installed, handprints were obvious on the etched glass, rendering the windows worthless.

d. Custom door handles. The handles were well made and worked perfectly. However, the surface coating on about half of the handles was flawed. This required the buyer to open every custom package to individually inspect each item.

All of the above buyers made the same mistakes. They all failed to put clear quality requirements into their manufacturing contract, along with clear penalties to be assessed (liquidated damages) against the manufacturer for failing to meet quality benchmarks. They also failed to conduct an initial inspection of their products in China, and they made full payment before conducting a secondary inspection upon arrival of the products in their home countries.

5. Payment Terms

The standard system in China for OEM manufacturing is for the Chinese manufacturer to require a 30% to 70% down payment with the remaining 30% to 70% due on shipment. Most U.S. and European product buyers then wait until the product arrives in their country before they do their inspection. This means that when the product buyer discovers a product problem, its Chinese manufacturer has already been paid in full, so it has little to no incentive to deal with the issue, and they rarely do. Instead, they will mostly just stall and stall and stall.

Though it is possible to litigate in China to resolve these issues (assuming you have done everything right with your China OEM Agreement to allow for this), Chinese factories understand that the total value of any single container of goods seldom justifies the cost of international litigation, so they tend not to care. The best way to prevent these sorts of problems is to have your China-specific manufacturing contract clearly outline this process, and give you clear recourse should anything go wrong.

A Seven Step Plan for Drafting a China-Specific Manufacturing Agreement

Navigating the complexities of international manufacturing, particularly in China, requires planning and legal foresight. Drafting a China-specific manufacturing agreement is a crucial step towards establishing a secure and productive relationship with your Chinese manufacturer. The following seven-step plan outlines the essential stages involved in creating a manufacturing agreement tailored to China’s unique challenges and legal landscape.

This structured approach will ensure is intended to ensure that your manufacturing agreement is comprehensive, legally enforceable, and aligned with both your business objectives and the regulatory environment in China.

Step 1: Initial Consultation

  • Identify your manufacturing needs and goals.
  • Consult with legal counsel experienced in Chinese manufacturing agreements.

Step 2: Choose the Right Manufacturer

  • Conduct due diligence on potential manufacturers. For what this typically entails, check out The Essential Role of China Due Diligence.
  • Discuss with your potential manufacturers your specific requirements to gauge capability and willingness to comply.

Step 3: Negotiate Key Terms with your Potential Manufacturer

  • Get at least general agreement on price, quantity, delivery dates, quality standards, and payment terms.
  • Discuss dispute resolution preferences, contract language, and applicable law.

Step 4: Draft the Manufacturing Agreement

  • Obtain the correct Chinese company name and have the contract stamped/sealed by the manufacturer.
  • Have your experienced China manufacturing lawyers draft your contract — usually in Chinese as the official language and an English translation for your review.
  • Include detailed specifications and requirements for product, quality control measures, penalties for non-compliance, and explicit contract damages.

Step 5: Review & Negotiation of the Manufacturing Contract

  • Review the draft with your legal counsel and negotiate any necessary revisions with your potential manufacturer.

Step 6: Finalize & Execute the Manufacturing Contract

  • Both parties sign and stamp/seal the contract.

Step 7: Ongoing Monitoring & Quality Control (post contract)

  • Conduct regular audits and inspections to ensure compliance.
  • Maintain open communication with your manufacturer as this aids in resolving issues that might arise.

Real-World Insights: Case Studies on China Manufacturing Agreements.

The following two case studies starkly illustrate the critical difference a well-crafted, China-specific manufacturing agreement can make, highlighting both the pitfalls of oversight and the benefits of diligence. These real-world scenarios underscore the potential consequences of neglecting formal contracts with your Chinese manufacturers and highlight how comprehensive China-centric manufacturing agreements can safeguard your business interests and ensure successful manufacturing outcomes.

Case Study 1: A Negative Outcome Due to Lack of Proper Contract

Background: A mid-sized European electronics used Purchase Orders (POs) and Invoices to buy a new range of smart home devices from its longstanding Chinese manufacturer. Neither the POs nor the Invoices made any mention of product quality or delivery timelines. The European company was relying entirely on oral assurances of quality and timelines.

Problem: Upon receiving the first shipment, the European company discovered that a large number of the products failed to meet the orally agreed-upon product specifications. Worse, the entire shipment arrived three months late, causing the European company to miss out on the critical holiday sales window. The Chinese manufacturer, citing misunderstandings about specifications and timelines, refused to take responsibility. This company contacted my law firm’s international dispute resolution team to see about securing recourse from the Chinese manufacturer that did it wrong.

Outcome: Though the European company was facing substantial financial losses from unsold inventory and missed market opportunities, our law firm chose not to take on the case against the Chinese manufacturer because without a detailed contract specifying quality standards, delivery dates, and recourse for non-compliance, we felt that the European company had little leverage to negotiate compensation or secure corrective action from the Chinese manufacturer.

Case Study 2: A Positive Outcome with a Well-Drafted Contract

Background: An American home goods company had my law firm’s China manufacturing lawyers draft it China-specific manufacturing agreements with all dozen or so of its China suppliers. Their contract included the following:

  • Dispute Resolution: Specified disputes would be resolved in China via CIETAC arbitration.
  • Language: Designated Chinese as the official language of the contract.
  • Quality Control: Included detailed quality specifications and liquidated damages for non-compliance.
  • Delivery Timelines: Defined strict delivery dates with a liquidated damages clause for delays.

Outcome: Midway through production, a quality audit revealed deviations from the material specifications. Citing the contract, the American brand was able to promptly negotiate a resolution with the manufacturer, who corrected the issue at its own expense to avoid damages. The subsequent “make-up” shipment met all specifications and arrived on schedule, and soon enough so that our client was able to meet (or nearly meet) all of its downstream deadlines.

Conclusion

To ensure the security and success of your manufacturing operations in China, proactively addressing the essential elements of pricing, quantity, delivery schedules, product quality, and payment terms in your contractual agreements is paramount. You should ensure that your agreements are not just verbal, but are captured in a legally binding, China-centric manufacturing contract that fully protects your interests.

Be sure to conduct thorough quality inspections in China before making significant payments to your suppliers. Withhold your final payment. For more on what it takes to succeed when having your manufacturing done in China, check out Manufacturing in China: Minimizing Your Risks by Doing Things Right.

This approach to drafting a manufacturing agreement and the outlined safeguards help mitigate the common risks associated with manufacturing in China, providing a solid foundation for successful international partnerships.

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A Foreign Language Contract is Your Key to Clarity https://harris-sliwoski.com/chinalawblog/a-foreign-language-contract-is-your-key-to-clarity/ Wed, 27 Mar 2024 10:58:30 +0000 https://harris-sliwoski.com/?post_type=chinalawblog&p=135425 Foreign Language Contracts are Key I must have told clients at least a hundred times in my career that “foreign language contracts are key.” In this post, I explain why I so often say this and why this is the case. The Complexity of Language in Legal Contexts One of the things I often do

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Foreign Language Contracts are Key

I must have told clients at least a hundred times in my career that “foreign language contracts are key.” In this post, I explain why I so often say this and why this is the case.

The Complexity of Language in Legal Contexts

One of the things I often do as a lawyer is review emails before they go to our clients, in large part to make sure everything in them is clear. I once got an email from one of my law firm’s international litigators saying we should “cabin” a particular issue. This lawyer grew up in North Dakota and went to college there. He then went to law school at the University of Minnesota and for many years practiced at a leading Minneapolis litigation law firm. I had never heard the word “cabin” used as a verb and I had to look it up. Google defines this as “to confine within narrow bounds,” but most dictionaries do not have any definition for cabin as a verb at all. Turns out this is Minnesota term since Minnesota is famous for just about everyone having a cabin on one of its 15,000+ lakes.

The Challenge of Legal Fluency Across Languages

I mention this internal email with this litigator to highlight how even among native-born Americans there can be language confusion. Multiply that by one hundred and you have what can and does happen in international transactions, even among people supposedly fluent in both languages.

Take my law firm as an example. We have around half a dozen lawyers fluent in Chinese, and yet only about half of them are fluent enough to be able to craft legal documents in both English and Chinese. The same holds half dozen or so lawyers fluent in Spanish.

Just yesterday a potential client asked me if we had any lawyers who knew Spanish. My response was that we have many. But then later in the call, when we were discussing the need for a Spanish language contract, I told him that less than half of our Spanish speaking attorneys truly have that capability. There is a big difference between being able to watch and understand Lupin in French  and being able to have sufficient French language skills to draft an agreement that can determine whether millions of dollars are gained or lost. I was a French major in college and I lived in France for two years, but when it comes time for drafting French language agreements, I always defer to a native French-speaking lawyer. I lived in Spain for a year and I just today hit day 750 on my Spanish Duolingo, but I still need to defer to one of our lawyers for whom Spanish is their native language.

The Importance of Native-Language Contracts

It is important to have your contracts with foreign companies be in their language as well, for a whole host of reasons. The main reason is to achieve clarity.

Having a well-written contract in their native language assures you that your foreign counterparty truly understands what you want of it. It puts the two of you on the same page. For example, if you ask your overseas product supplier if it can get you your product in thirty days, it may answer with a “yes” pretty much every time. But if your supplier signs a contract mandating that its failure to ship your product within thirty days will require it pay you 1% of the value of the order for each day late, you will know it is serious about the 30-day shipment terms. We see this particularl issue all the time and it usually stems from the foreign manufacturer believing that you were merely asking whether a 30 day delivery would sometimes be possible.

It is common for companies to come to our law firm wrongly believing they have a “deal” — based entirely on English-language communications — with a foreign company and believing our job as lawyers is merely “to document it.” We look at the deal and immediately note the following:

  • There is no way the foreign company would agree to one or more provisions and either it did not (and the foreign company is mistaken) or if it did, but it likely did not understand to what it agreed.
  • There are one or more things about the deal that are bad for both sides and both sides would haver benefitted by changing those.
  • There are one or more things that are completely illegal in one or both countries.
  • There are one or more things that are completely unworkable or nonsensical in one or both countries.

Sometimes these companies will have been negotiating for months (even years) and will have made many trips back and forth between the two countries, and everything they have done is either completely unworkable or illegal.

The Solution: Truly Bilingual Negotiation and Involvement

What should these companies have done? They should have spent the extra time and money to use truly bilingual negotiators from day one and every single step of the way and — to the extent possible — the true decision-makers should have been intimately involved in negotiations from day one and every single step of the way as well. This usually costs more in time and money in the short term, but it nearly always ends up saving way more time and money in the long term.

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International Payment Terms: The Long Edition https://harris-sliwoski.com/chinalawblog/international-payment-terms-the-long-edition/ Tue, 26 Mar 2024 10:58:30 +0000 https://harris-sliwoski.com/?post_type=chinalawblog&p=133032 Mastering International Payment Terms: Essential Strategies for Business Security International trade opens up a world of opportunities for businesses, but it also presents a minefield of risks, particularly with payment terms. Cross-border trade disputes commonly involve issues related to payment terms and conditions, and without proper safeguards, unfavorable payment terms can cripple a company’s cash

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Mastering International Payment Terms: Essential Strategies for Business Security

International trade opens up a world of opportunities for businesses, but it also presents a minefield of risks, particularly with payment terms. Cross-border trade disputes commonly involve issues related to payment terms and conditions, and without proper safeguards, unfavorable payment terms can cripple a company’s cash flow, undermine its supplier relationships, and expose it to legal and financial vulnerabilities.

This post aims to equip businesses with strategies to navigate the complexities of international payment terms, mitigate their risks, and foster secure, profitable transactions.

The Landscape of Risks

In international trade, payment terms define the timeline and conditions under which payments are made between buyers and suppliers. These terms are pivotal in managing cash flow, but they also harbor the following risks.

1. Financial Risks

Upfront payments demand an outlay of cash from the buyer, putting a strain on financial resources. This becomes particularly challenging when dealing with large transaction volumes. Delays in delivery or receiving products that don’t meet expectations can exacerbate these financial pressures.

2. Operational Risks

A full payment made upfront can potentially reduce the supplier’s incentive to meet agreed timelines or quality standards, as they have already secured their payment.

3. Market Risks

The interval between payment and delivery is vulnerable to market dynamics. Exchange rate volatility can impact the cost effectiveness of a transaction, introducing an element of unpredictability.

4. Supplier Insolvency Risks

There’s the ever-present danger of a supplier running into financial difficulties or becoming insolvent after receiving an upfront payment. Such scenarios can lead to the non-receipt of ordered goods, inflicting financial damage on the buyer.

5. Legal and Recourse Risks

Recovering funds in cases of disputes, non-performance, or subpar quality can prove to be daunting, especially when navigating the legal landscapes of different jurisdictions. You know the saying: possession is nine tenths of the law.

Strategic Mitigation: Ensuring Secure and Profitable Transactions

Businesses can use a wide range of strategies to mitigate their risks associated with international payment terms. These include leveraging financial instruments like escrow services, letters of credit, and performance bonds, as well as implementing practical measures such as balanced payment terms, currency hedging, robust legal agreements, continuous supplier evaluation, and fostering strong relationships. The optimal approach often involves a combination of these strategies, tailored to the specific transaction, industry, and level of trust with the supplier.

1. Escrow Services

Process: A neutral third party holds the payment until both buyer and seller fulfill their contractual obligations. The buyer deposits the funds into the escrow account, and the escrow agent releases the funds to the seller upon verification of delivery and product acceptance (or upon meeting other agreed-upon milestones).

Drawbacks: Escrow fees can add to the transaction cost. There might be delays in releasing funds if disagreements arise between the buyer and seller. This is not common in many countries, especially in Asia.

2. Letters of Credit (LCs)

Process: A financial institution (issuing bank) guarantees payment to the seller upon presentation of specific documents outlined in the LC (typically bill of lading, commercial invoice, etc.). These documents act as proof that the seller has met the agreed-upon terms of the sale.

Drawbacks: LCs can be expensive due to bank charges. They involve complex paperwork and strict adherence to the outlined conditions. Any discrepancies in the documents can lead to delays or rejection of payment.

3. Performance Bonds

Process: A financial guarantee issued by a bank or insurance company on behalf of the seller. If the seller fails to meet its contractual obligations (e.g., late delivery, poor quality goods), the buyer can claim compensation from the bond to cover its losses.

Drawbacks: Performance bonds add extra cost to the transaction. Obtaining a bond can be time-consuming for the seller, especially for smaller companies.

4. Purchase Order Financing

Process: A financier provides the buyer with upfront funds to pay the seller based on a purchase order. The buyer then repays the financier with interest after receiving and selling the goods.

Drawbacks: This option can be expensive due to financing fees. It can also increase the buyer’s debt burden if sales of the purchased goods are slow.

5. Currency Hedging

Process: Financial instruments (e.g., forward contracts, options) are used to lock in exchange rates, mitigating the risk of unfavorable fluctuations between the buyer’s and seller’s currencies.

Drawbacks: Hedging strategies can be complex and require market expertise. They may not completely eliminate exchange rate risk, and there could be costs associated with implementing the hedge.

6. More Balanced Payment Terms

Negotiating balanced payment terms, such as 30/70 or 50/50 splits, where a portion of the payment is made upfront and the remainder upon delivery or following a satisfactory product inspection, can alleviate some of the financial burdens on the buyer. This approach also keeps the supplier motivated to adhere to the agreed-upon quality and timelines.

7. Robust Legal Agreements

Comprehensive contracts that clearly articulate payment terms, delivery schedules, quality standards, and dispute resolution mechanisms are indispensable. They provide a legal framework that safeguards the interests of all parties involved.

8. Continuous Supplier Evaluation and Relationship Building

Regular audits and inspections of the manufacturing facilities and processes ensure compliance with the agreement’s terms. This proactive measure helps identify potential issues early, allowing for timely interventions and solutions. Building solid, trust-based relationships with suppliers can lead to more favorable negotiation outcomes on payment terms. Understanding each other’s business needs and constraints fosters a cooperative environment conducive to resolving issues and finding mutually beneficial solutions.

Case Studies on International Payment Terms

1. Small clothing importer: A new clothing company struggled to secure favorable payment terms from an overseas clothing manufacturer. The overseas manufacturer demanded close to full payment upfront, but the clothing company lacked sufficient capital to buy its products on those terms.  Solution: Our lawyers helped the clothing company negotiate a 50/50 split payment term – half upfront and half upon delivery. This balanced the clothing company’s financial burden and provided sufficient assurance to the manufacturer.

2. Large machinery importer: A manufacturing company needed to import a specialized machine from Mexico. The high transaction value made them apprehensive about upfront payment. Solution: Our lawyers helped the manufacturing company work with a bank to establish a letter of credit. This assured the seller of payment while allowing the buyer to inspect the machine upon arrival before releasing the full payment amount.

3. Software development outsourcing: A tech startup hired a team in Asia to develop their mobile app. Due to the intangible nature of the service, the startup was hesitant to pay the full amount upfront. Solution: The startup opted for a milestone-based payment plan enumerated in a product development agreement. Partial payments were released upon completion of specific development stages or milestones, ensuring quality and progress while mitigating risk.

4. Perishable goods importer: A food importer needed to source fresh produce from South America. Given the perishable nature of the goods and the long transit times, they were concerned about quality and timely delivery. Solution: The importer utilized an escrow service, where funds were released to the supplier only after the goods were inspected and approved upon arrival. This provided assurance of product quality while protecting the importer’s financial interests

Tailoring the Best Strategy

The optimal strategy for mitigating payment risks depends on several factors, and businesses must carefully evaluate their specific circumstances to determine the most appropriate approach. Here are some key considerations:

Transaction Size: For larger transactions involving significant sums of money, the potential financial risks are amplified. In such cases, instruments like letters of credit or escrow services might be preferred despite their added costs. These provide robust safeguards against non-performance or insolvency risks. For smaller transactions, the cost-benefit analysis might favor simpler options like balanced payment terms or relying on robust legal agreements.

Industry: Different industries are susceptible to varying degrees of risk. For example, industries dealing with perishable goods might require faster payment cycles to ensure timely delivery and maintain product quality. On the other hand, industries with longer production lead times might benefit from more flexible payment terms that align with their operational timelines.

Level of Trust with the Supplier: When engaging with a new or untrusted supplier, utilizing a letter of credit, escrow service, or performance bond can provide added security and mitigate the risks associated with non-performance or insolvency. However, for established, long-term partners with a proven track record, flexible payment terms based on mutual trust and understanding might be more appropriate, fostering a cooperative and efficient working relationship.

By carefully considering these factors, businesses can tailor their approach and select the most suitable combination of mitigation strategies. For instance, a large transaction within a time-sensitive industry involving a new supplier might warrant using a letter of credit and a performance bond. Conversely, a smaller transaction with a trusted, long-term partner in a less time-critical industry could rely on balanced payment terms and robust legal agreements.

The key is to thoroughly evaluate the unique circumstances of each transaction and adopt a proactive, risk-based approach to international payment terms.

Conclusion

mastering the intricacies of payment terms is paramount to safeguarding your business’s financial health and operational stability. While the risks are multifaceted, ranging from financial strains to legal vulnerabilities, they can be effectively mitigated by implementing a strategic combination of proven strategies.

By leveraging financial instruments like escrow services, letters of credit, and performance bonds, negotiating balanced payment terms, engaging in currency hedging, fostering strong supplier relationships, and establishing robust legal frameworks, businesses can navigate the complexities of cross-border transactions with confidence.

Ultimately, the key to success lies in a tailored, proactive approach that considers the specific factors of each transaction, such as size, industry, and the level of trust with the supplier. By adopting this mindset and staying vigilant, businesses can unlock the vast opportunities of international trade while shielding themselves from the pitfalls of unfavorable payment terms.

Remember, the path to secure and profitable international trade is paved with diligent planning, continuous monitoring, and open communication. Embrace these strategies, and watch as your global ventures flourish, transforming international trade from a source of uncertainty into a wellspring of growth and prosperity.

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Why Your International Manufacturing Agreements Need a Good Bill of Materials https://harris-sliwoski.com/chinalawblog/why-your-international-manufacturing-agreements-need-a-good-bill-of-materials/ Mon, 25 Mar 2024 10:58:46 +0000 https://harris-sliwoski.com/?post_type=chinalawblog&p=135424 The Crucial Role of the Bill of Materials Manufacturing agreements between product buyers and their manufacturers typically come with all sorts of clauses dealing with choice of law, indemnification, time of delivery, failure rate, price, payment, and various other contractual provisions. The Bill of Materials can often make or break the success of a manufacturing

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The Crucial Role of the Bill of Materials

Manufacturing agreements between product buyers and their manufacturers typically come with all sorts of clauses dealing with choice of law, indemnification, time of delivery, failure rate, price, payment, and various other contractual provisions. The Bill of Materials can often make or break the success of a manufacturing relationship, but this document is too often either ignored or given short shrift.

The Well-Drafted Bill of Materials

The Bill of Materials is a list of the components to be used in fabricating the proposed product. A good Bill of Materials, inserted as an appendix or addendum to an Original Equipment Manufacturing (OEM) agreement, should specify in excruciating detail exactly what your manufacturer must use in manufacturing your product. A well drafted and precise Bill of Materials minimizes the likelihood of confusion and future mistakes, which in turn saves you money by reducing product defects and recalls.

Common Pitfalls in OEM Manufacturing Agreements

My law firm’s international manufacturing lawyers have seen far too many OEM manufacturing agreements that did not have a Bill of Materials and far too many OEM agreements where the Bill of Materials was not made a part of the contract.  Perhaps even worse, I have seen Bills of Materials that were made a part of the contract, but that allowed the manufacturer to substitute any component in the Bill of Materials whenever it felt like it. There is oftentimes nothing wrong with allowing your manufacturer to make substitute materials with your knowledge and approval, but there is a lot wrong with a Bill of Materials that gives your manufacturer complete discretion to substitute in materials.

When a problem arises, you should be able to cross-reference your Bill of Materials with the actual product to see if the correct components are present. When I see manufactured products with high return or defect rates, the cause is almost invariably the manufacturer having used cheaper components. But far too often, I also find that there was nothing in the OEM contract or in the Bill of Materials (or in the two of them working together) that contractually prevented the manufacturer from having done exactly what it did. Often, the quality of your Bill of Materials will determine whether or not you have any recourse against your manufacturer for bad product.

If you want to reduce your chances of defective or dangerous product, you cannot just rely on your manufacturer to do the right thing in terms of your product’s materials or components. It is your responsibility to make sure your manufacturer uses the correct materials in manufacturing your product.

A well drafted Bill of Materials is the first step towards that.

The Bill of Materials is not just a list; it is a blueprint for manufacturing success. Its role in clarifying expectations and minimizing errors cannot be overstated and the clarity and detail of your BOM can be instrumental in achieving product excellence. Invest the time and effort to get it right—your product’s quality, your brand’s reputation, and your bottom line will thank you.

For more on international manufacturing agreements, check out The Key Components of International Manufacturing Contracts.

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China Software Licensing: Is Chinese Government Registration Required? https://harris-sliwoski.com/chinalawblog/china-software-licensing-is-chinese-government-registration-required/ Sun, 24 Mar 2024 10:58:05 +0000 https://harris-sliwoski.com/?post_type=chinalawblog&p=135420 Was just cc’ed on an email from one of my law firm’s China software licensing lawyers to a client that licenses its software through a distributor in China. Our licensing lawyer was responding to a question about registering the software licensing agreement with the Chinese government. The below is a portion of our lawyer’s response

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Was just cc’ed on an email from one of my law firm’s China software licensing lawyers to a client that licenses its software through a distributor in China. Our licensing lawyer was responding to a question about registering the software licensing agreement with the Chinese government. The below is a portion of our lawyer’s response to that question, watered down to remove any identifiers. I am posting this email because it explains the vagaries of registering license agreements in China and when that is necessary and when it may not be.

In general, if a contract is characterized as a “license,” payments under that contract are characterized as “royalties.” Under Chinese law, to receive royalty payments, the contract must be registered as a foreign technology transfer contract. This can be simple, or it can be complex, depending on the district in which the paying party is located.

Some districts in China treat software agreements as normal sale contracts and do not require registration. The decision is made at the foreign exchange bank that will process the payments. If the bank does not require registration, you do not have an issue. We typically suggest having the paying party check with its bank. If the bank will process payments in the ordinary course, there is no issue. I am sorry to make this so complex, but the issue is unsettled in China and so decisions must be made on a case-by-case basis.

Note that this goes back to who is actually responsible for making payments to you: your distributor or the end user. This matters because it is the bank of the payer that will make the decision, so it is important to get clear about the party responsible for paying. If your software distributor will always be the one to pay you, you need only deal with this issue once. If each end user will be the payer, you will have to deal with this issue with each end user separately, increasing your burden and your risk. Since you have already received a payment without having this issue arise, it is probable the locals are treating your contract as a normal sales contract, which is good for you.

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China Representative Offices: Think Before You Leap https://harris-sliwoski.com/chinalawblog/china-representative-offices-think-before-you-leap/ Sat, 23 Mar 2024 11:58:44 +0000 https://harris-sliwoski.com/?post_type=chinalawblog&p=135415 China Representative Offices With so many companies becoming reluctant to go “all in on China,” our China lawyers are seeing an increase in companies looking to just “dip their toe” into China via a Representative Office. Unfortunately, there are inherent limitations on China Rep Offices, and those limitations mean they seldom make sense for most

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China Representative Offices

With so many companies becoming reluctant to go “all in on China,” our China lawyers are seeing an increase in companies looking to just “dip their toe” into China via a Representative Office.

Unfortunately, there are inherent limitations on China Rep Offices, and those limitations mean they seldom make sense for most companies.

Rep Offices “represent” in China the foreign company back home. Rep Offices are not a separate legal entity; they are the China representative of the foreign company. Most importantly, they are not allowed to engage in profit making activities. Chinese law limits them to performing “liaison” activities. They cannot sign contracts or bill customers. They cannot supply parts and after-sales services for a fee. They cannot have any employees. Perhaps most importantly, they cannot earn money in China or take any payments from a Chinese person or business.

Limitations of China Representative Offices

China Rep Offices are pretty much limited to engaging in the following activities:

  • Conducting research
  • Promoting their foreign company owner
  • Coordinating their foreign company owner’s activities in China
  • Other activities that do not and are not intended to generate a profit

Considerations Before Forming a China Rep Office

Because forming a Rep Office in China is faster, cheaper, and easier than forming a Wholly Foreign Owned Entity (WFOE), companies often consider forming a Rep Office in China to test the waters there, with the intention of switching over to a WFOE once it becomes clear China will be viable for them.

We generally discourage this because “switching” from a Rep Office to a WFOE is not really a switch at all. It involves both shutting down the Rep Office and forming a WFOE pretty much from scratch. Because the cost of forming a Rep Office, shutting down the Rep Office, and then forming a WFOE, will be considerably higher than just forming a WFOE, forming a Rep Office with the intention of later forming a WFOE seldom makes sense. Companies are usually better biting the bullet and forming the WFOE straight away.

Other times, companies have come to my law firm believing they need a China Rep office because they need a Chinese entity to sell their product into China. Oftentimes though, these companies can sell their product into China without having to create any in-China footprint at all.

There are times where a Rep Office makes sense. By way of one example, my firm set up a Rep Office for a US company that sells US made equipment for around $2 million each. This company has no plans to start manufacturing its equipment in China so there would be no need to form a WFOE for that. It already had an arrangement with a Chinese company to repair its equipment sold into China, so no need to establish a WFOE for that purpose either. This company merely wanted an on the ground China presence to improve its sales and to let its customers and potential customers know it is serious enough about China to commit to having an office there.

China Rep Office Requirements

There are three basic requirements for forming a China Rep Office:

  • There must be a lease of an approved space for a period of at least one year beyond the approval date of the Rep Office. Care should be taken with this requirement, since many jurisdictions accept leases only from a small group of approved office buildings. Shanghai, for example, is one such jurisdiction. The lease must be registered, which can also cause problems in some jurisdictions.
  • There must be a designated Chief Representative who will manage the affairs of the Rep Office.
  • There must a foreign entity (typically a limited liability company or a corporation) that the local office represents; private individuals and partnerships cannot establish a Rep Office in China. In addition, some jurisdictions in China do not allow newly formed entities to form a Rep Office.

The local authorities usually issue their decisions on Rep Office approval within around thirty days, at which point the Rep Office must do many of the other things typically required of businesses in China. However, in some parts of China, this decision can take much longer, depending on the whims of the local officials.

There are two major issues that make working with Rep Offices unattractive:

  • Even though Rep Offices are not permitted to earn income in China, they are nevertheless subject to taxation. There is a 10% tax on the GROSS EXPENSES of the Rep Office. If the Rep Office is large and has a number of employees, this tax can be quite high.
  • A Rep Office is not permitted to directly hire Chinese nationals. All hiring of Chinese nationals must be done indirectly through contracting with a Chinese employment agency such as FESCO. Recent changes in the Chinese labor contract law have made such contracts extremely unattractive. Rep Offices can directly hire foreign nationals.

China Rep Offices: Think Before You Leap

The bottom line on Rep Offices is to think before you leap and not get seduced by their relative ease of formation or by an entity formation company that is push you to do a China Rep Office because they are so simple to do.

Every once in a while, our China lawyers will get called by someone who formed a Rep Office (usually through a formation company) within the last year or so who tells us they are “now ready to switch over” to a WFOE so they “can start making money” in China. These people believe this “switch” will involve little more than issuing a one-page notice of change to a Chinese government office and they are shocked to learn that it will actually involve an expensive shutdown and a brand new WFOE formation.

Do not let yourself become one of “these people.”

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FREE Webinar: Success for Chinese businesses in the US | April 24th https://harris-sliwoski.com/chinalawblog/free-webinar-success-for-chinese-businesses-in-the-us-april-24th/ Fri, 22 Mar 2024 09:58:20 +0000 https://harris-sliwoski.com/?post_type=chinalawblog&p=135408 Register Here 本网络研讨会专为希望在美国开展业务的中国企业家、投资者和企业而设计,意在简化您所需要了解的美国商业相关法律。 Designed for Chinese entrepreneurs, investors, and businesses looking to establish a foothold in the United States, this webinar aims to simplify the US business laws you need to know. 合伙人 Jonathan Bench 和受过中国培训律师 Emily Chen 将讨论联邦法律和州法律对建立实体企业和开展业务的重要性。我们将探讨劳动法、移民法、如何在美国筹集投资资本以及如何构建外国直接投资机会等相关复杂的问题。 Partner Jonathan Bench and China trained lawyer Emily Chen will discuss the importance of federal and

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Register Here

本网络研讨会专为希望在美国开展业务的中国企业家、投资者和企业而设计,意在简化您所需要了解的美国商业相关法律。

Designed for Chinese entrepreneurs, investors, and businesses looking to establish a foothold in the United States, this webinar aims to simplify the US business laws you need to know.

合伙人 Jonathan Bench 和受过中国培训律师 Emily Chen 将讨论联邦法律和州法律对建立实体企业和开展业务的重要性。我们将探讨劳动法、移民法、如何在美国筹集投资资本以及如何构建外国直接投资机会等相关复杂的问题。

Partner Jonathan Bench and China trained lawyer Emily Chen will discuss the importance of federal and state laws for establishing entities and doing business. We will explore the intricacies of employment law, immigration law, how to raise investment capital in the US, and how to structure foreign direct investment opportunities.

无论您是初创企业还是老牌企业或投资者,本次网络研讨会都将有助于您掌握相关法律知识,避免合规陷阱,助力您在美国市场取得成功。演讲将以普通话进行。

Whether you are a new or established business owner or investor, this webinar will equip you with the legal know-how to avoid compliance pitfalls and succeed in the US market. This webinar will be conducted in Chinese.

Register Here

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New AD/CVD Petitions: 2,4-Dichlorophoxyacetic Acid (2,4-D) from China and India (AD/CVD) https://harris-sliwoski.com/chinalawblog/new-ad-cvd-petitions-24-dichlorophoxyacetic-acid-24-d-from-china-and-india-ad-cvd/ Wed, 20 Mar 2024 10:58:48 +0000 https://harris-sliwoski.com/?post_type=chinalawblog&p=135343 New AD/CVD Petition: 2,4-Dichlorophenoxyacetic Acid (2,4-D) On March 14, 2024, antidumping (AD) and countervailing duty (CVD) petitions were filed against imports of 2,4-Dichlorophenoxyacetic Acid (2,4-D) from the People’s Republic of China and the Republic of India.  The petitions were filed by Corteva Agriscience LLC.  2,4-D is the active ingredient used in a wide variety of

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New AD/CVD Petition: 2,4-Dichlorophenoxyacetic Acid (2,4-D)

On March 14, 2024, antidumping (AD) and countervailing duty (CVD) petitions were filed against imports of 2,4-Dichlorophenoxyacetic Acid (2,4-D) from the People’s Republic of China and the Republic of India.  The petitions were filed by Corteva Agriscience LLC.  2,4-D is the active ingredient used in a wide variety of herbicides.

These AD/CVD investigations will be conducted by two federal agencies.  The International Trade Commission (“ITC”) will investigate whether the subject imports are a cause of injury.  The U.S. Department of Commerce (“DOC”) will investigate whether the subject imports are being sold to the United States at less than fair value (“dumping”) or benefit from unfair government subsidies.  Both agencies have to make affirmative findings of injury or threat of injury (ITC) or of dumping or subsidies (DOC) in order for AD/CVD duties to be imposed on the subject imports.

Scope

The petition proposed the scope definition for this case as follows:

The merchandise covered by this investigation is 2,4- dichlorophenoxyacetic acid (“2,4-D”). 2,4-D has the Chemical Abstracts Service (“CAS”) registry number of 94-75-7 and the chemical formulaC8H6Cl2O3. The 2,4- D component of any derivative products of 2,4-D, including but not limited to, amine salt and ester forms of 2,4-D are covered by the scope of the order.

Salt and ester forms of 2,4-D include, but are not limited to, 2,4-D salt (CAS 2702-72-9), 2,4-D diethanolamine salt (CAS 5742-19-8), 2,4-D dimethyl amine salt (CAS 2008-39-1), 2,4-D-isopropylamine salt (CAS 5742-17-6), 2,4-D tri- isopropanolamine salt (CAS 32341-80-3), 2,4-D BEE (CAS 1929-73-3), 2,4-D 2- ethylhexylester (CAS 1928-43-4), and 2,4-D -isopropylester (CAS 94-11-1). All 2,4-D, as well as the 2,4-D component of its salt and ester forms, is covered by the scope irrespective of purity, particle size, or physical form.

The conversion of a 2,4-D salt or ester from a subject 2,4-D acid, or the formulation of nonsubject merchandise with the subject 2,4-D, its salts, and its esters in the country of manufacture or in a third country does not remove the subject 2,4-D, its salts, or its esters from the scope. For any such formulations, only the 2,4-D, 2,4-D salt, and 2,4-D ester components of the mixture is covered by the scope of the order.

2,4-D, its salts, and its esters are classified under Harmonized Tariff Schedule of the United States (HTSUS) subheading 2918.99.2010. Other merchandise subject to the current scope, including the abovementioned formulations that may be classified under 3808.93.0500 and 3808.93.1500. The HTSUS subheadings and CAS registry number are provided for convenience and customs purposes. Thewritten description of the scope of the petition is dispositive.

Alleged AD/CVD Margins

Petitioner calculated estimated dumping margins for the subject countries:

China –  143.73-388.53%

India – 62.55%

Petitioner did not provide any specific China or India subsidy margin calculations.

Named Exporters/ Producers

Petitioner included a list of companies that it believes are producers and exporters of the subject merchandise.  See attached list here

Named U.S. Importers

Petitioner included a list of companies that it believes are U.S. importers of the subject merchandise.  See attached list here.

Estimated Schedule of Investigations

March 14, 2024 – Petitions filed

April 3, 2024 – DOC initiates investigation

April 4, 2024 – ITC Staff Conference

April 29, 2024 – ITC preliminary determination

August 11, 2024 – DOC CVD preliminary determination (assuming extended deadline) (6/7/24 – unextended)

October 10, 2024 – DOC AD preliminary determination (assuming extended deadline)

(8/21/24 – unextended)

February 22, 2025 – DOC final determination (extended)

April 8, 2025 – ITC final determination (extended)

April 15, 2025 – DOC AD/CVD orders issued (extended)

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Decoding U.S. Tariff Classifications: A Comprehensive Guide https://harris-sliwoski.com/chinalawblog/decoding-u-s-tariff-classifications-a-comprehensive-guide/ Tue, 19 Mar 2024 16:04:41 +0000 https://harris-sliwoski.com/?post_type=chinalawblog&p=135362 Decoding U.S. Tariff Classifications – A Comprehensive Guide For businesses involved in international trade, effectively navigating U.S. custom regulations can lead to significant cost savings, compliance benefits, and a smoother trade process. A key component of this process is understanding tariff classifications. What is a Tariff Classification? Tariff classification assigns a unique code to every

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Decoding U.S. Tariff Classifications – A Comprehensive Guide

For businesses involved in international trade, effectively navigating U.S. custom regulations can lead to significant cost savings, compliance benefits, and a smoother trade process. A key component of this process is understanding tariff classifications.

What is a Tariff Classification?

Tariff classification assigns a unique code to every imported product, like assigning a passport number to a traveler for identification. This code helps custom officials identify the product and determine the duties payable. In simpler terms, it is like assigning a unique identification number to each type of product, which helps custom officials understand what the product is, what it is made of, and what it is used for. This identification number then determines how much tax should be paid on it, and how much of that product is being imported or exported out of the country.

The Harmonized Tariff System (“HTS”) VS Harmonized Tariff System of the United States (“HTSUS”)

The key to tariff classification is to understand the Harmonized Tariff System (“HTS”) and how it works in facilitating global trade. The HTS is like a global language for trade. Every product gets its own unique code, making it easier for countries worldwide to understand what is being traded. This standardization simplifies international trade, ensuring that all countries classify products in a consistent manner.

Though HTS aims for uniformity, its implementation can vary across different countries. These variations arise from national priorities, economic policies, and trade agreements unique to each country. For example, though the HTS code for a particular product might be the same up to the sixth digit level worldwide, the import duties applied on that product may differ significantly from country to country. Put differently, Country A might impose a higher tax on bicycles for economic reasons and Country B might have a lower tax on the same bicycles imported from Country C due to a trade agreement between Countries B and C. Understanding these nuances is crucial for businesses operating in multiple countries, as it affects how to calculate your costs of trade.

The Harmonized Tariff Schedule of the United States (“HTSUS”) provides a more granular product classification tailored to U.S. trade requirements. For example, all bicycles are classified under the same six-digit HTS code worldwide, but the HTSUS further breaks down broad categories like bicycles into specific product descriptions such as “bicycles having both wheels not exceeding 63.5 cm in diameter.” To illustrate further using another product as an example, though the HTS broadly classifies computers, the HTSUS divides them into more precise categories like laptops, desktops, and tablets. Similarly, consider a video camera, which under the HTS might be classified under a general code like 8525.89, which broadly covers “Television cameras, digital cameras and video camera recorders; other; television cameras.” In the HTSUS, the same digital camera would be classified more specifically under a code like 8525.89.2000, which narrows it down to “Studio television cameras excluding shoulder-carried and other portable cameras.” As in the bicycle illustration above, this level of detail in the HTSUS helps U.S. custom officials determine the exact duty rate applicable to imported video cameras, ensuring a more precise tax and import duty assessments.

How to Determine the Correct Tariff Classification Under The HTSUS

The starting point to any product classification analysis is to understand that each product is assigned a ten-digit code in the HTSUS. The next step is to understand how the HTSUS is organized. HTSUS is organized like a tree-starting with broad branches: its Chapters. Its Chapters are then subdivided into smaller ones: Headings and Subheadings for specific items.

Figuring out the specific classification for a product , this typically involves two main steps, and a possible third step, when unsure. Those steps are as follows:

  1. Understand the Product. Know the product’s composition, use, and function.
  2. Review the HTSUS. Examine the HTSUS to find the appropriate chapter, heading, and subheading using the General Rules of Interpretation (“GRI”).
  3. Binding Rulings: When unsure about the product’s HTSUS code, request an advisory opinion and or a binding ruling from U.S. Customs and Border Protection (“CBP”) to get clarification on the tariff classification of that product.

Real-World Consequences of Misclassification

Misclassifying a product’s HTSUS tariff codes can have significant and far-reaching consequences for businesses. Understanding these impacts is crucial for ensuring compliance and avoiding costly errors.

  1. Financial Penalties and Increased Costs. Incorrect classification often results in underpayment or overpayment of duties. In cases of underpayment, businesses may face penalties and be required to pay the difference in duties. Overpayment can affect competitiveness and profitability due to unnecessarily high costs.
  2. Customs Delays and Disruptions. Misclassified products often trigger custom inspections, leading to delays in clearance. This can disrupt supply chains, affecting inventory levels, sales, and overall business operations.
  3. Legal Implications. Repeated misclassification issues can lead to legal action from custom authorities. This can tarnish a company’s reputation and result in legal fees and court proceedings.
  4. Complications in Trade Compliance. Tariff classifications are integral to trade compliance. Errors can complicate compliance with trade agreements and export-import regulations, potentially limiting market access and business opportunities.
  5. Audit and Reassessment Risks. Custom authorities may conduct audits on importers with histories of misclassification, leading to reassessments of past imports and further financial implications.

Below are three real-life examples that illustrate the significant impacts of a tariff misclassification:

Case Study 1: A few years ago, an electronics company faced significant fines after mistakenly classifying a new model of smartphone. The device had advanced features that warranted a different HTSUS tariff code than the company’s standard model. This misclassification resulted in the underpayment of duties, which led to penalties and a lengthy legal process to rectify the error.

Case Study 2. A textile importer incorrectly identified a shipment of blended fabric garments as 100% cotton. The actual material was a mix of cotton and synthetic fibers, which fell under a different HTSUS tariff code with a higher duty rate. This error was discovered during a routine audit, resulting in this company having to pay back duties and a fine.

Case Study 3. A small family-owned business specializing in artisanal honey production decided to expand its market by exporting to the United States. The company initially classified its honey under a generic HTSUS tariff code for food products. However, the HTSUS required a more specific classification based on the type of honey, and whether it was organic, flavored, or contained added sweeteners. After facing delays due to prior misclassification, the company sought customs advice from an expert who gave them the specific HTSUS classification for their honey, which significantly reduced their duty rate, and expedited custom clearance into the United States.

Conclusion

By mastering tariff classifications, you can reduce your costs and prevent penalties and shipment delays. By deploying the necessary resources and by making tariff classification a priority your business can avoid costly mistakes and become a savvier global trader. Our team of attorneys and trade experts can provide you with the guidance you need to master U.S. tariff complexities.

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Chinese Manufacturers Go Abroad: New Business Relationships for a New Era https://harris-sliwoski.com/chinalawblog/chinese-manufacturers-go-abroad-new-business-relationships-for-a-new-era/ Mon, 18 Mar 2024 10:58:01 +0000 https://harris-sliwoski.com/?post_type=chinalawblog&p=135223 Last week, I spoke at Brigham Young University’s annual China Conference, which is now in its eighth year under BYU professor Peter Chan. This year the conference’s theme was Peace Together: Continuing a Culture of Collaboration. Professor Chan has become a good friend over the past few years since I started attending the conference. He

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Last week, I spoke at Brigham Young University’s annual China Conference, which is now in its eighth year under BYU professor Peter Chan. This year the conference’s theme was Peace Together: Continuing a Culture of Collaboration. Professor Chan has become a good friend over the past few years since I started attending the conference. He is a brilliant person and also very kind and pragmatic, which came through in the conference title and the way the conference was carried out. This text below contains excerpts from my presentation:

Introduction

I am honored and humbled by this opportunity to speak with you today. When I arrived at BYU for my first semester in the fall of 2000, I was amazed and overwhelmed by its size and the intensity of a university education. Growing up as a religious minority in a small town in southwest Wisconsin, I was so happy to finally be among my people. I came to BYU hoping to understand who I was and my life’s mission.

I generally found what I was looking for at BYU, but I didn’t find all of my answers. Some of those required years of subsequent experience, which has given me perspective. Perspective is not something you can artificially accelerate by thinking harder about what might happen. You need to get out and live it.

My Professional Background

I am an international business lawyer with an emphasis on the China market, or as we are calling it now, the “China +1” market. I specialize in business transactions. That means I help companies move their goods and provide services across international borders. I generally do this from the comfort of my home while wearing sweatpants and a t-shirt. (Don’t get too excited. It took me 10 years to get to the point where I could do that!)

But a few times each year I travel internationally to speak at conferences, meet clients, and build my professional network. And sometimes I get dressed up to speak to groups of bright young people and business owners who are trying to learn how to better succeed in the international marketplace.

Building Business Relationships

I am an expert in business relationships. It may surprise you to think of a business lawyer as being an expert in relationships, but my type of lawyering is at least as much about understanding people as understanding facts and the law. Understanding people is key to understanding their motivations in business.

In my session, I will focus on the art of building good international business relationships. All businesses depend on relationships. These relationships start with a company and move in any number of directions.

We will discuss the importance of relationships in the Chinese culture, China’s growth over the past 20 years, and how Chinese manufacturer’s relationships with the outside world have been changing over the past few years.

I will provide two case studies from my clients, one a Chinese entrepreneur and the other a US entrepreneur establishing a new type of business relationship with his Chinese manufacturing partner.

Types of Business Relationships

It is helpful for me to think about these business relationships as being internal or external. Internal relationships deal with cofounders, joint venture partners, financing partners, investors, employees, independent contractors, and advisors. I think of these internal relationships as residing on the horizontal plane.

Then we have external relationships with suppliers, manufacturers, distributors, and customers. I think of these relationships as residing on the vertical plane because they track the movement of business inputs and outputs, as well as money.

This is not a comprehensive relationship framework, but I think that it is helpful for you to know how a business lawyer thinks about the world of business relationships.

Relationships Lead to Contracts

In this interconnected web of business relationships, my professional work begins and ends with contracts. Contracts may not sound very exciting, but they are similar to natural laws. Even if you do not believe in them, they are there, and they impact you whether you like it or not.

If I can use a simple analogy, I think of the business relationship as the body and the contract as the exoskeleton. If I draft my contracts in the best way possible, then they will protect my client’s interests and key relationships while also providing a certain amount of flexibility in the relationship, usually around points of vulnerability in the relationship.

Guanxi in the Chinese Culture

If you know anything about China and Chinese culture, then you know that guanxi (关系) is a paramount concept. It might be the most talked-about term. When we use the term “relationship” in English, it does not carry the same cultural weight as guanxi does in Chinese.

Let me give you an example. A few weeks ago, I was at a small Lunar New Year celebration at a friend’s house. My friend and I have known each other professionally for a couple of years, but I had never met his wife. She is from Mainland China and a successful self-made entrepreneur in Utah. My friend introduced me to her as a business lawyer who speaks Chinese, and her eyes immediately lit up. She asked me some questions about my work and then exclaimed, “We need to do business together! And I definitely have some friends who will be interested in meeting you!” So, we immediately connected on WeChat, and we now have a preliminary guanxi bond. This experience happens rarely in Western cultures to this degree, but it happens frequently in Chinese business circles.

I Start to Learn About Guanxi and China

During the early 2000s, I first lived in Hong Kong as a missionary for The Church of Jesus Christ of Latter-day Saints and then in Sichuan Province as an English teacher, for a total of three years. I went there with only the goals of trying to help people in Hong Kong and to learn Mandarin in Sichuan.

I was barely out of high school and did not have much context for what I was seeing. But as I found myself immersed in Chinese culture, I started to understand how important relationships were for them and in my own life. I was extremely far out of my comfort zone, but I quickly learned that I liked people, and people seemed to like me. I didn’t know whether that was because I was making the effort to learn their languages or because I had an open mind about the food and culture. Either way, I felt like I was slowly building up a significant asset in my life – my network of people who I knew, liked, and trusted.

China’s Business Rise

My exposure to China closely tracked China’s rise as to become a global superpower. China joined the World Trade Organization in 2001, which was the same year I arrived in Hong Kong. I was not aware that this was the start of China’s rise to become the world’s manufacturing powerhouse. By 2009, China had become the world’s largest exporter of goods. That market share continued to increase, and China now makes up over 28% of total global manufacturing. But in the past four quarters, China’s manufacturing activity has continued to shrink. There are globally significant reasons for this shift.

COVID Impacts China and the World

We all lived through COVID-19, but you may not have been aware at the time how much the pandemic shocked the global supply chain. Normally, it takes about 40 days for goods to arrive from China by ship, but during the pandemic it was closer to 70 days. And on top of that, shipping costs per container increased from about $1,300 per container in 2020 to over $20,000 per container.

These systemic shocks and effects were extremely difficult for businesses to deal with, but the emotional impact on business owners was probably more significant than the financial impact. As businesses all over the world watched how quickly and thoroughly the Chinese government could lock down a port, a neighborhood, or an entire city, they started to worry. This worry was not the worry from the Trump Era tariffs that many businesses had been dealing with for years. This worry was more foundational because businesses could not ignore the risks associated with Chinese government decisions. Many decided that the world’s supply chain was too dependent on China.

Chinese Manufacturers Start to Look Abroad

In the 2000s and early 2010s, China was the land of low cost labor and minimal regulatory enforcement. By the late 2010s and early 2020s, China had become a land of increased labor costs (now 1/3 higher than Mexico), significant regulatory oversight, increased risk, and diminishing profit margins.

Consequently, the relationship between Chinese manufacturers and their buyers has been changing over the past few years. These manufacturers previously found it very easy to make and sell products. Many didn’t think beyond just optimizing their production lines. They didn’t worry about branding or building international sales channels. Make and sell, copy, and paste. But manufacturing demand has declined as companies seek to retool their supply chains. This changing environment requires different tactics from these manufacturers.

In the middle of this global chaos the past few years, I have noticed that some Chinese manufacturers are coming into their own. For instance, some extremely innovative products are being produced in China, built on decades of increasing manufacturing expertise. And I have encountered some very experienced and smart Chinese entrepreneurs who really understand how to thrive in international markets.

Two Case Studies

Chinese Manufacturer of Electronics

Our client initially contacted my firm because he had a business opportunity with a Chinese manufacturer. His company began by setting up display infrastructure for large event venues. From there, the company grew into managing live events, from providing crew management, stagehands, technicians, and lift operators. Then the company moved into providing the media and entertainment infrastructure for large venues, such as hotels, churches, and casinos. This involves designing the entire audiovisual system and then purchasing and installing all audiovisual equipment for those mega venues.

Our client and his team have an expert eye for quality materials and quality products. While they were at a trade show, they came across a Chinese manufacturer. This manufacturer had developed the technology to provide an LED overlay onto any existing piece of glass to turn it into a display screen, for which they won an award at a prominent industry expo. Our client and his team immediately understood two things.

First, they understood the potential commercial scale for such an amazing product. Second, they understood that the manufacturer would need help to really perform well in the US market. Our client had never really dealt with Chinese manufacturers, and he knew that he needed to get this business relationship right. The client reached out to our firm so that we could help them deal with cultural, legal, and linguistic differences that had already started to manifest themselves. The manufacturer’s leadership is smart enough to know that they can’t just sell this product via ecommerce. They need local market help to differentiate their product from other potential competitors and to really build its sales channels, providing a world class offering to the US market and beyond.

Both sides of this equation understand that they need each other locked into a symbiotic relationship. A simple arm’s length transactional relationship is not going to be enough for them to succeed with this innovative product in a new marketplace.

Fractionalized Asset Ownership

Our Chinese client is an online marketplace for sports and Pokémon trading cards, much like eBay. The owner started collecting basketball cards in 1996 as the NBA started to get more exposure in China. He began his career in China with a US multinational firm, and then he opened a restaurant, which grew to a chain of 80 restaurants. After selling that venture, our client established this new venture.

Our client is an entrepreneur at heart. He has an expansive vision for where he wants his company to go. He has seen websites in the US and abroad that offer fractional investment opportunities in various collectible assets. And he wants to build a world-class investment platform for trading cards and other assets.

He has assembled a team, including the Chinese manufacturer that produces sports cards for some European soccer clubs. And he has decided that he wants to comply with all of the applicable US regulations as he establishes his new marketplace. He visited the US last year, and as I sat across the table from him, I was impressed more with him than any other Chinese business owner that I had dealt with. I have every confidence that he will succeed again as he has already done.

Our client is ambitious and experienced enough to know that that, other than hiring good US legal counsel, he does not necessarily need a US partner to succeed in this new venture. But he has already set his sights on Europe, as well, which will require additional partnerships. He is initiating all of these relationships, and I think that potential partners will appreciate his drive and vision. And he has the flexibility to know when he needs to bring in outside partners to succeed.

Conclusion

I think about this concept of guanxi a lot, including business relationships. The question is what does this world of changing relationships mean for your life, and what will you do with your relationships? I want to close with some simple and obvious facts that were initially taught to me on the streets of Hong Kong over 20 years ago. These are simple and may be obvious, but I believe they are also profound.

First, you should be learning Chinese because it opens up the door for you to speak to over a billion people. You should make sure that you encourage others to learn Chinese. This is even more important today because English language instruction in China is not being taught at the levels it was in the early 2000s when I was teaching there (see here).

As China retrenches and reinforces its Great Wall, we need to move more than halfway toward China in building these bridges of friendship and understanding over any barriers. Those people who learn Chinese now will be those guiding foreign policy, international relations, and international business in future generations.

Second, you should be building meaningful relationships with people wherever you go. You should trust that in your life you will meet people who will enrich your experience and help you in important and amazing ways. And you should trust that for some people, you will be the one who will enrich their lives and help them in important and amazing ways.

I hope that our time together today has been meaningful for you. I believe that our relationships can be one of our greatest gifts and opportunities in this life. Thank you.

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