China Manufacturing: Don’t Be Too Eager to Make a Deal

Recently we have worked on several matters that involved reviewing multiple contracts and weeks’ worth of emails and WeChat correspondence to piece together how a China manufacturing deal went awry, with the aim to salvage the relationship between the Chinese manufacturer and our client, but mostly with the aim to determine whether we can help our client recover some of its funds that are now in the manufacturer’s Chinese bank account. The funds were paid in exchange for some substandard products. It is important to mention that these clients came to us only after the deals went bad.

Here are some conclusions I have drawn from this process:

Don’t be too eager to make a deal. In the Phase One trade deal between the U.S. and China, one major complaint is that the deal is not really a good deal. In the Trump administration’s haste to make a deal, they put together an agreement that is substandard for a variety of reasons, most notably because it lacks any real enforcement mechanism other than backing out of the deal.

Even good companies with experienced China hands can neglect to incorporate the best China business practices during contract negotiations if they are too focused on signing the contract. This generally happens when companies that are new to China think they cannot afford an attorney to help them conduct due diligence on their Chinese counter-party or draft a solid China contract. These companies typically believe they have enough general business experience not to need an attorney; they have great rapport with their China counter-party and are convinced they will be able to work through any future issues amicably; they have never had an issue in any previous business deal they have done on a handshake or a bare bones contract; their domestic attorney that does not specialize in China matters has looked over it; and/or they are on too tight a timeline to conduct due diligence or negotiate key terms that will matter if the deal starts to fall apart.

Get a good contract now. As a rule, companies need to use strong contracts crafted for enforcement in China unless you are sure you can get the contract enforced in your home country. If you intend to enforce the contract in your home country, then you need a strong contract crafted for your home country. You need a legal expert to confirm to you that you have a strong likelihood of success in a lawsuit.

This is not the same as your gut reaction that because you “know” you’re dealing with a “major Chinese company” that you will have no problem finding a cache of the Chinese company’s assets in your home country. Most of the really big Chinese companies never (and I mean never) do foreign deals with their actual main company. Instead, they set up asset-less shell companies for those deals. By way of one example, our China lawyers have represented parties in at least a dozen deals with one of China’s biggest and best-known companies and every single one of those deals was with a Chinese company formed no more than a month before the contract was signed.

If the Chinese manufacturer’s assets are only in China, you need a law firm that can produce a quality China manufacturing contract for you. Your normal (or top notch) U.S. law firm likely can produce a great U.S. manufacturing contract for you, but they will certainly miss some key elements for a China manufacturing contract.

Interestingly, our international manufacturing lawyers (and our international dispute lawyers too) are starting to see these same sort of contract problems with companies that moved their manufacturing out of China to some other country, such as Malaysia, India, Mexico, Vietnam or Colombia. These companies were so excited about their future prospects in these “new” countries that they failed to get a good contract in place before “getting going.” Then — usually within months — some sort of problem arises and they call one of the lawyers at my law firm and we are forced to try to solve things without a good contract in place.

Stick to your guns during your negotiations. Even if you have a good manufacturing contract, if you or someone in your company with authority decides that one or two provisions are not important (when they actually are), then you are consciously removing your China armor. You should have saved the money you spent on your manufacturing contract because you will need it (and a lot more) to pay your attorney to help you figure out where your negotiations went wrong, why your contract is now substandard, and (hopefully) discerning your best avenue for recovering some of your damages from the substandard products you received and now have no use for.

Make sure your team and your Chinese counter-party know who has authority to bind the company. You need to be clear who in your organization has “actual authority” and who has “apparent authority” to negotiate and contract for the company. Even someone without actual authority can have apparent authority if you do not make clear to your Chinese counterpart that they can only contract with someone who has actual authority. You need to provide this information in writing.

After the contract has been negotiated and signed, and after you have wired your funds and received substandard product, it is not a strong defense to say that you did not approve the prior actions of someone affiliated with your company, whether it is a low-level employee or third party agent.

Good record-keeping only helps if you don’t make a misstep. You may have meticulously documented every exchange with your Chinese manufacturer. And you may believe that you have a good recollection of the events. And you may believe that your employees, co-owners, and other trusted people like your Chinese-based sourcing agent all think and believe and act in lockstep with you. But chances are, you are probably wrong on one or more of these beliefs. Keep good records of all conversations in case you need to fight with your manufacturer at some point down the road. But you also need to prepare yourself for the probability that there will be something less than ideal in your records that you will need to deal with.

China contracting is fraught with dangers even on a good day, and in today’s environment we haven’t had a good day in many years. Remember that making a good deal now does not outweigh the discovery later that your good deal is really a bad deal. The famous Chinese idiom of 同床异梦 (one bed, two dreams) always potentially applies to you and your Chinese manufacturer and to you and everyone else in your organization. Don’t forget to take a step back and review everything before plunging ahead with a seemingly good deal.

Oh, and this review I did. Almost without exception, we ended up having to tell the client that because of its less than stellar contract and its string of various mistakes along the way, we did not think it would make sense for it to pursue their Chinese manufacturer any further. In other words, these companies were now out millions of dollars and we did not think it economical for it to spend a penny more trying to get it back. The client initially complained about our conclusion, to which we essentially said, “Look, if you want to keep paying us to try to recover money for you that we do not believe can be recovered, we will not stop you from doing so, but we do not recommend it.” They ended up taking our advice.

Don’t let this happen to you. Be careful out there.