How to Protect Against China Factory Closures

China Factory CLosures

In the last few months, our China lawyers have received multiple emails from companies whose China suppliers have been shut down due to environmental concerns.

The big issue for our lawyers isn not so much what do you do if your factory in China closes, as those situations usually are governed by the actual facts on the ground. For us the interesting question is what can and should you be doing now to avoid a situation where your China factory closes.

Lately, the China attorneys at my firm have been receiving emails like this:

I run a _________ company in __________ and I have come upon a situation in which I would like to ask for a legal opinion. We were having our [widgets] made by a factory in Guangzhou that is part of a large Chinese company with more than a dozen factories throughout China. Unfortunately, this one factory that was making our [widgets] is the only factory this company has that makes [widgets].

To make a long story short the company is saying the Chinese government has shut down its [widget] factory for “environmental reasons” and they will not be supplying us with our [widgets]. This is very bad for us because we now have a long line of very unhappy retail customers and many of them have told us they are done with us (even for our other products) because of our failure to deliver them the widgets we promised.

Can we sue this company in China?

Our typical response is usually something like the following:

You can sue but can you win? Without reviewing your contract with this company, I have no way to know what you can or should do. If you have a good contract (preferably in Chinese and chopped by the Chinese company) that makes clear the Chinese company must provide you with products and that does not have a force majeure provision broad enough to include this factory being closed by the Chinese government for environmental reasons (even if the fault of the Chinese company) then we should consider pursuing litigation.

But what can you do to avoid a similar situation for your company? The following can help:

  • Recognize that the Chinese government is more concerned with social harmony than with economic numbers and that is why it continues to shut down highly-polluting factories.
  • Many Chinese exporters, particularly those that compete with companies from lower-wage countries like Vietnam and Bangladesh, are suffering — in particular in low-tech, low-wage industries such as textiles, clothing, shoes and low-end electronics and toys. Some of these companies are claiming to have been shut down by the Chinese government when in reality they shut down on their own because they were losing money. Foreign companies that do business with Chinese companies in these industries must keep up their guard.
  • The key to weathering China’s onslaught of factory shutdowns will be for foreign companies to focus on due diligence at a company-to-company level.

Even though China’s low-end companies are suffering both from environmental shutdowns and rising costs, its high-end companies are getting bigger and deeper, as they strive to provide a product or a service (or a product and a service) that can compete anywhere. The existence of such Chinese companies is not new but these sort of companies are proliferating and growing in strength, and more Chinese companies are realizing that stepping up their game is the best way for them to survive. Co-blogger Steve Dickinson hit on this trend in his post Contracts For Product Purchases In China. In other words, the importance of choosing your China partner — which was always critical — has become even more so.

Our best advice to protect your financial interests is that you document all your transactions in simple, concise language so if there is a fight over the failing Chinese company’s assets, it will be clear what actually belongs to you. If your Chinese factory is going to shut down after you have paid for your products and your Chinese factory has made them, you want to be able to walk away with them. You also should do your utmost to determine the financial wherewithal of your Chinese counter-parties before you pay anything.

None of these things are foolproof or even close, but if you do all of these things you are a lot less likely to get burned, slowdown or shutdown or not.

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