How to Conduct Business with Chinese Companies That See a Dark Future

“It’s not dark yet, but it’s getting there.” Bob Dylan, from Not Dark Yet

In the 1990s, I represented a number of international fishing and timber and mining companies that did business with Russia. This was not so long after the fall of the Soviet Union and there were a bunch of large Russian companies — many of them formerly state-owned — looking to do deals with my clients, mostly American and Western European companies. My clients would set up long term deals with these Russian companies which nearly always went bad quickly because the Russian company would grab whatever money there was and walk away.

This would leave my clients dumbfounded at how the Russian company would so “irrationally” sacrifice so much money in the long term to grab a relatively small amount of money in the short term. I would find myself explaining the following to them:

You have to understand that for most Russian companies there is no long term. They are used to the Soviet Union where the rules and the laws constantly and unpredictably changed to their detriment. They do not believe they will be able to operate freely five years or even one year from now. So though you see them as having irrationally sacrificed massive long term gains for much smaller short term rewards, they see themselves as having quite rationally grabbed what they could while it was still there.

I am writing about this now because China today is feeling a lot like Russia in the 1990s. I am getting the sense that many Chinese companies are pessimistic about their futures and they are acting accordingly. Our China lawyers are seeing evidence of this everywhere.

China’s economy is hurting right now. On the one hand, food prices are soaring. See China’s consumer prices rise at fastest clip in nearly 8 years, as pork prices continue to soar. On the other hand, exports are plunging. See China’s exports decline for third successive month in October. Reliable economic indicaters (as opposed to official government statistics) paint an economy in trouble. See China’s economy is in more trouble than markets think. See also China’s car sales drop for 16th consecutive month as October falls 4 per cent. The tariffs are not helping nor is the Chinese government’s crackdown on private businesses. On top of the economic issues, many Chinese companies have become both wary of and angry at the West, particularly the United States. This too makes things riskier for foreign companies.

We are seeing the results of all this in many ways.

Practically every week one of our China lawyers will get an email or a phone call from someone who bought product from China and received nothing in return or nothing even approaching what they actually ordered. This sending of “junk” instead of real product has spread to pretty much every industry in China and ordering your products from allegedly reputable online sites provides little to no protection.

The below email (modified so as not to reveal anything) is par for the course:

I worked with a company in China to manufacture doggy beds [I made this up] on which I have a U.S. patent pending and also have trademarked. I received samples from them and all was good. I placed an order for 50,000 pieces and they are of the wrong material and falling apart. They told me they would send me the right product but now they are ghosting me. I cannot sell the product they sent me. I’m still trying to get my new product to market but that is proving really difficult because I have been hurt so badly financially. Can you help?

My response to these sort of emails is usually to explain that the odds of our getting even some of their money back are less than 50 percent and they should think long and hard before throwing good money after bad. I refrain from telling them what they should have done differently, but I can discuss that here and it is the following:

These things usually happen when product buyers do not conduct sufficient due diligence on the seller. Do your due diligence before you send money. Send people you trust to investigate the manufacturing site. Do a site inspection on goods before payment. Make sure the company exists and is legally able to conduct the business for which you will be paying it. Doing just these few inexpensive things will greatly increase your odds of not getting scammed.
These things often happen with Chinese companies that want to make a few final overseas sales before they shut down and disappear. Just imagine the profits to be made from three $350,000 sales for which laughably bad or no product is ever provided. Now just imagine the incentive Chinese manufacturing companies have to sell and not supply foreign companies right before (or sometimes even right after) they shut their doors for good.
Oftentimes the Chinese company that committed the fraud does not exist. It is not registered anywhere in China or if it is registered as a real company in China it is registered for something like kitchen repairs, not for manufacturing whatever product it is they sold you.
These fraudsters are smart and there are good reasons why they spend the money to send you something instead of nothing at all and why they initially say they will remedy the problems and why they often continue making that claim. Sending even really bad product is less likely to lead to criminal charges than sending no product at all. They can tell the police that they sent you the product you ordered and it’s not their fault those Americans/Europeans/Australians are so picky. By stalling you they can keep their scam alive. They’ve paid for advertising and for a website and they’ve even bought the really bad product and they want to maximize these expenditures. Act early on these sorts of problems and your chances for a recovery increase.
Use a contract that actually works for China and that sets forth clearly what you are buying and what happens if your China supplier fails to comply. See China Contracts: Make Them Enforceable Or Don’t Bother and China Contracts that Work.
Know the market price of whatever it is you are seeking to purchase before you purchase it. Do not trust a company that gives you an unreasonably low price quote.
Consider a small trial order to reduce your risk. The problem with this is that many scammers will provide you with a good trial order and then scam you when you order the full amount. But if you combine this with a contract that works for China and proof that the company actually exists and is operating legally, you will be greatly lowering your risks.

One more thing that warrants its own special mention. Do not buy product from China without first registering your trademark in China because many of the fraudsters sending out bad product are now also registering YOUR brand name and/or product name and/or logo in China as THEIR trademarks in China and then coming back later seeking to sell you these trademarks for a lot of money under threat of blocking your products from leaving China for violating THEIR trademarks. See 8 Reasons to Register Your Trademarks in China.

Speaking of trademarks and IP, we have also seen a massive increase in what I call early IP theft, which also stems from Chinese companies’ lack of confidence in their future. We wrote about this in China Trademark Theft. It’s Baaaaaack in a Big Way:

For years we probably averaged a call a week from someone who had lost their trademark to China to someone who had gone ahead and filed it before the non-Chinese company did so. Then, starting maybe 5 or 6 years ago, the number of these calls declined. I have ascribed this decline to two things. First, foreign companies started getting wiser about the need to get their brands, their logos and their company names registered as trademarks in China. Second, and of equal importance, China instituted rules to try to stop Chinese manufacturers and trading companies from registering as trademarks the brand names and logos and company names of the foreign companies for whom they were manufacturing or sourcing products. To simplify a bit, your China agent could not hang on to a China trademark that you were using before you brought them on for your manufacturing or product sourcing. We went from one China trademark “theft” call a week to maybe one a month.

But starting about a year or so ago, our China trademark lawyers started getting a ton of China trademark theft calls and the number of those calls has been accelerating ever since. Why has the tide on trademark “theft” come in again? Two reasons. One, there is hardly a sole in China who does not know how to get around the prohibition on an agent registering the trademark that rightfully should go to the foreign company for whom it is acting as an agent. If your manufacturer in Shenzhen wants to secure “your” trademark in China it will not go off and register it under its name as it knows that cannot work. So instead of registering the trademark under its own Shenzhen company name, it will ask a cousin or a nephew in Xi’an to register it under its company name, making it nearly impossible for you to invalidate the trademark. Two, many (most) Chinese factories are hurting and they desperately want to improve their profit margins. What better way to do so than to sell a product under a prestigious or well-known American brand name — or even just any American brand name? See Your China Factory as your Toughest Competitor.

There is a third reason trademark and IP theft has so dramatically increased in China of late. More Chinese companies have stopped thinking long term. Just yesterday, in The Right Way to Reduce Your China Product Costs, we wrote how Chinese companies have become wary of their foreign buyers leaving them for tariff-free manufacturing outside China:

But you must be very careful in negotiating lower prices from your Chinese factory because just asking for lower prices could cause your company some very serious blowback. The first thing you should know is that Chinese factories are sick and tired of losing so many of their customers and they are very wary of anyone who they believe may leave them for another factory in another country.

If your Chinese factory is not convinced it will be making your widgets for another three years, it knows it can make more money by making “your widgets” for itself and then selling them wherever it can. In the last year, more foreign companies have come to us after their Chinese manufacturer “stole” their product (and its IP) without ever having made a single one for the foreign company than in the last five years combined.

We are also seeing an incredible uptick in Sinosure cases. We wrote about this earlier this year in China’s Sinosure: It’s Back and It Wants Your First Born:

Like clockwork, the downturn in China’s economy is leading to a big uptick in American companies contacting our international litigators for help in fending off Sinosure threats. For the full import of what I mean by Sinosure threats, I urge you to check out Owe Money to China? Meet Sinosure, Leviton Law Firm, and Brown & Joseph and China Sinosure: What You NEED to Know. To summarize, Sinosure is China’s Export and Credit Insurance Corporation and what that means in real life is that it insures most of China’s exports. It insures those exports by paying its policyholders when a foreign company fails to pay for product it has received from its Chinese supplier.

So how does an increase in Sinosure cases against American companies reflect the downturn in China’s economy? Well over half of the many Sinosure cases our lawyers have seen over the years arise from bad product delivered by the Chinese manufacturer. The typical Sinosure case involves a Chinese company sending over (let’s say) $500,000 in bad product. The American company cannot sell that product for its usual $950,000, but instead is forced to unload it for $350,000. The American company tells all this to the Chinese company and seeks to resolve its alleged $500,000 debt to its Chinese supplier with a one time $250,000 payment. The Chinese company goes silent and a few weeks later, the American company receives an aggressively threatening letter from one of Sinosure’s U.S. lawyers.

In As trade war deepens, a state-owned insurer in China helps soften the blow, Reuters News wrote about the increasing number of Sinosure cases:

Last year, as the trade war started to bite, Sinosure’s claim payouts surged more than 40% to nearly $2 billion, according to data from the company, which is owned by an investment company controlled by the finance ministry.

Payouts are poised to climb further this year with tariffs rising, according the company’s internal estimates.

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Dan Harris, a lawyer who represents U.S. importers, said he has received increasing requests for help dealing with Sinosure demands for payment on behalf of Chinese exporters.

“Before the trade war, I might go … four, five months without getting a Sinosure email, now I’m getting four or five a week,” said Harris, managing partner at international law firm Harris Sliwoski

Sinosure is China’s state-owned export insurance company that pays Chinese manufacturers that were stiffed by their foreign buyers and then seeks to collect from the foreign buyers that allegedly failed to pay. Before this year the Sinosure cases we handled always involved situations where if the Chinese manufacture did not get Sinosure involved it would almost certainly never get paid. We are now seeing Sinosure cases where the Chinese manufacturer has made what we think are fraudulent policy claims to Sinosure because they are desperate for cash and they don’t care about maintaining their relationship with their foreign buyer.

Lastly, our China lawyers are dealing with an increasing number of situations where the Chinese side of a China joint venture has essentially taken over the joint venture and stops communicating with its foreign joint venture partner. Maybe these joint ventures are no longer even profitable, but our clients are entitled to determine this and if the joint venture should be shut down, our clients are also entitled to a share of the joint venture company’s existing assets. For how to prevent/mitigate such problems, check out this article on China joint ventures. It’s as though the Chinese side in these joint venture partnerships views it as their patriotic duty to kick their foreign partner to the curb.

For some companies, China’s increasing risks now exceed its rewards, but for others this is not at all true. Do you really need a legal entity in China with Chinese employees or might your company be better off with no operations in China beyond a third party distributer or reseller? Our China lawyers have been doing a lot of work in the last six months helping our clients reduce their China footprint and thereby reduce their China risks. No matter what you are doing in or with China, now is a good time to look at how you too can reduce your risks. The following posts are relevant for this:

Bottom Line: China in the last year has become far riskier on nearly all fronts. It is important you recognize this and act accordingly.