Whenever my law firm is retained to represent an American or European company that is providing goods or services to China, one of the first things we want to know are the payment terms. If our client is going to get 100% payment upfront, before providing any goods or services, a written contract may not even be necessary. The old expression about possession being nine-tenths of the law holds true, though I’d probably update it to say that it’s 99 percent of the law when it comes to China.
Unfortunately, all-upfront deals with Chinese companies as the payees are nearly as rare as manure from a rocking horse.
What we usually see are situations in which the Chinese buyer wants to pay 30% to 40% upfront, with the remainder due upon completion of the services or delivery of the goods. Under this sort of payment situation, the contract becomes critical. But even with a good contract, our client is at risk and we usually suggest they hold out for better payment terms. Something like at least half up front and the remaining half upon completion. Or better yet, a 70-30 arrangement. More than anything, we like to see our client getting enough upfront to cover their costs, whether or not their China counter-parties make the second payment.
The following are some examples of what we have seen:
1. One of our clients that makes custom factory equipment charges its China buyers 40% before it starts production because that 40% is roughly its cost of production. After our client completes production, the China company must pay another 40% of the total price or the equipment will not ship. The final 20% gets paid once the China company signs off on the product upon delivery, at which point our client sends someone to help with installation. Because our client makes custom factory equipment, if it cannot get paid by the customer that commissioned the equipment, it can only sell equipment to others for much less than full price.
2. One of our clients is an ultra-specialized, ultra high-end designer with more business than it can handle. It will not put in one minute for a China client unless and until that client has paid 100% upfront for the project. It also – quite wisely – has us make very clear in its contracts exactly what the China client gets for its upfront flat fee and that any work beyond that must also be paid in advance. These sorts of provisions are important to prevent the Chinese side from claiming its project encountered problems due to our client’s breach.
By way of an aside, this is a classic example of why there is no one answer regarding the best location and law for a dispute. We have countless times written how most of the contracts we write for our American and European clients provide for disputes to be resolved in China. See e.g. Drafting China Contracts That Work. Providing for disputes to be resolved in China will almost always make sense in a situation in which the greater expectation is that the Chinese side will breach a contract by not paying or by stealing IP. But if, as is the case for this client, there is no chance of the Chinese company not paying (because they’ve already paid in full) and no chance of it stealing our client’s IP, it makes sense to force the Chinese company to come to our client’s home turf if it wants to sue. We thus put in a U.S. dispute resolution clause to minimize the likelihood of our client facing a lawsuit.
3. One of our food company clients charges its China clients 70% upfront and 30% upon delivery. The 70% covers all production and shipping costs, ensuring our client will not go in the hole even if the remaining 30% is never paid.
China’s economy is in decline and many Chinese companies are cash-strapped. Chinese companies are infamous for plundering foreign IP by not paying in full on their licensing deals. See China Licensing Deals so Horrible They are Hard to Believe. The same thing holds true on service contracts and we are increasingly seeing this with product sales transactions as well. In other words, there are countless companies that will take your services and products and never pay or never pay after the required initial payment. If you are going to sell product into China (or anywhere else internationally), you should consider employing the following strategies to increase your chances of not getting stiffed:
1. Secure full payment in advance. As noted above, this usually is not possible, but you should at least try. Note though that it can sometimes be difficult for Chinese companies to obtain government approval to make full payment in advance.
2. Conduct due diligence on your buyer.
3. Secure as much of the payment in advance as you can. Definitely negotiate for this, as negotiating for this usually does succeed in increasing upfront payment by at least 10 percent. This obviously will not guarantee you full payment, but it is better to lose some as opposed to all from a sale.
4. Secure a Documentary Letter of Credit. With this, you will be paid when there is documentary evidence you have shipped the product according to the terms and conditions of the letter of credit. Smart buyers typically require an inspection certificate to ensure the product complies with the specifications in the contract or the purchase order. This sort of letter of credit mitigates your risk because your buyer’s bank has irrevocably guaranteed to pay upon presentation of the required documents. We generally recommend that our clients secure this letter of credit from a major (not a tiny) Chinese bank, such as Bank of China, China Construction Bank, Industrial and Commercial Bank of China, China Development Bank, and Bank of Communications, or, better yet, from a branch of a known American, Asian or European bank. WARNING: Few Chinese companies will agree to letters of credit (especially from foreign banks) and we have seen more than our share of fake letters of credit. To encourage exporting, many countries, including the United States, make it fairly easy and cheap to purchase insurance to cover an improper non-payment on a letter of credit.
One more thing: your contract should also be clear on who pays Chinese taxes and ideally (of course), it should provide for the Chinese company to pay any and all Chinese taxes. For this to work well with the Chinese tax authorities, this should all be written in Chinese.