China Manufacturing Contracts: Yet Another Reason to Have One

What with China’s economy slowing, our international manufacturing lawyers have been getting a steady stream of emails and phone calls from companies (mostly American and European) whose Chinese manufacturers have shut down and/or disappeared. The below is email correspondence I recently had with one of these companies, changed to camouflage anything that might enable anyone to identify this company. I chose this American company simply because its situation nicely highlights what so may companies that have their products manufactured in China have been going through during the last few months due to lockdowns and China’s slowing economy.

I start with this company’s initial email to me:

Hi Dan,

I’m running into an issue with one of my factories getting ready to shut down for good. They have about $485,000 of our money that we sent them as the down payment for them to make our products. They tell me that they have already spent this money for materials but they will not tell me if they will be making any of our products and I am pretty certain they won’t. I do not even know whether to believe them that they bought the materials for our product. The factory is broke but I think they have a lot of assets in the factory.

Is this something you can help with? Is there something we can do?

After I determined that this company (NOT an existing client) did not have a written manufacturing contract with its China manufacturer nor did it have anything in writing that explicitly traced its payments to specific products made by the Chinese manufacturer I sent them the following email:

Your chances of seeing your money again are not good, especially if your factory does shut down and the creditors come calling. Those creditors might agree that the factory owes you $485,000, but because there is nothing in writing that explicitly ties your payment to anything that the factory may have purchased, you have no claim to anything specifically owned by the factory (including the products it has sitting there that we could argue were made just for you). With this being the case, these other creditors probably will take priority over you. At best, you will be thrown in with those other creditors, but usually there will be creditors with stronger claims than yours and they will end up with the assets. There is a slight chance there will be some funds to share among the second tier creditors but this is both very rare and unlikely to be much at all in any event. I say this because many of the other creditors probably have contracts with your manufacturer and their contracts make clear that the money they paid to the factory belongs to them unless and until the factory provides them with the product for which they have paid. Others may have security interests in factory property.

Your best shot is probably just to move as quickly as you can to try to get what you can though various tactics (letter writing, suing, etc.) before this company actually shuts down completely and starts the creditor feeding frenzy, but even for doing these things, your lack of a written contract will make things tough. Without a written contract, you just do not have much leverage and the factory will almost certainly want to deal initially with those it fears the most.

We’d be happy to try to help you but the chances of success are probably less than 50% and so you should ask yourself whether paying attorneys’ fees would be just throwing good money after bad. I do suggest you check in with your insurance broker/agent to see whether you might have any coverage for this sort of thing. Not likely but one never knows.

If you do want to get started on this, please let me know as soon as possible. No matter how weak your chances are now, they will only get weaker over time.

What are you seeing out there?