China’s Economic Downturn and the Implications for YOUR Business

1. China’s Tightening Currency Restrictions

And twice in the last month — and for the first time ever — I have heard from companies whose products are being delayed by their factory because their factory was unable to purchase needed components purportedly because the Chinese government was either not allowing them to use hard currencies to buy those components overseas or was simply delaying the approval of such payments. This is not the first time China has severely tightened down on the use of hard currencies, but this is the first time I’ve heard of it impacting its factories like this. For an example of a prior period where China cracked down on sending out hard currencies, See this 2016 post I wrote, entitled, Getting Money Out of China: What the Heck is Happening? In that post, I wrote that “if there is a common theme, it is that China banks seem to be doing whatever they can to avoid paying anyone in dollars.” That seems to be today’s theme as well.

2. Chinese Companies are Turning on their Foreign Partners

A notable shift since 2012 is the increasing willingness of Chinese firms to risk their relationships with foreign partners. As discussed in our piece, Your China Factory as your Toughest Competitor, this isn’t limited to the manufacturing sector. We often tell our clients “since you will essentially be educating your Chinese party in how to compete with you, you need contracts that limit what they can do when they do so

The CCP has intensified efforts to maintain stability and manage public discontent amid China’s economic downturn. Evidence of this includes the uptick in exit bans and arrests of foreign executives, making China increasingly precarious for them. See the Wall Street Journal did an article titled China Is Becoming a No-Go Zone for Executives. My law firm has done more China personal risk assessments — typically done to assess how safe it is for someone to go to China or stay in China — this year than in the entire history of our firm up until this year. Until this year, we would mostly just do these for executives who had been caught by fake police in a brothel. See The China Brothel Scam. It’s Baaaack.

Scaring foreign executives is also bad for China’s economy and it underscores the CCP’s emphasis on control over economic growth.

4. China Product Sourcing Problems

China’s downturn is transforming how Chinese and international companies interact. 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.

Foreign businesses that work with Chinese companies in these sectors need to be vigilant. Our China manufacturing lawyers are getting a steady stream of calls from companies experiencing problems with their product suppliers. Sometimes the foreign company has paid for a product and the Chinese company it paid no longer exists. Sometimes the Chinese company still exists but it needs “more money” from the Western company to buy raw materials for the product it already promised to produce.

Foreign managers need to understand what is happening in their own industries within China. This might mean having someone you trust visit your Chinese factory, warehouse, or office to look for warning signs of a company in distress. Or it might mean taking out insurance to cover your China business or transaction. A number of Chinese manufacturers are owned by Taiwanese, Singaporean or Hong Kong companies, and sometimes it is possible to secure guarantees from the foreign parent. Our law firm has also had a surge in conducting due diligence on Chinese factory companies.

Even more troubling, I would probably add that hardly a week goes by where we do not hear from a company that is being hounded by Sinosure for fake/dubious debts allegedly owed to a Chinese factory. See Fighting Back Against Fake (and Real) Sinosure Claims: A Primer. Chinese factories are using Sinosure to pursue these export insurance claims against their customers because they need the money to avoid having to shut down.

5. Geopolitical Implications

China perceives Western sanctions against Russia as a precursor to what could be imposed on them. In the West, the sentiment is that if China supports Russia more overtly, China too will face increased sanctions. However, in China, there’s a prevalent belief that the West aims to halt China’s ascent, leading to the notion that decoupling from Western economies is imminent. This has caused Chinese firms to shift their strategies, by competing with and/or steal from their own customers. None of what we are seeing coming out of China over the last few months has been a surprise because these things have always become more common when China’s economy is hurting.

Protecting Your Company Against China

Using China-specific contracts is vital to prevent Chinese companies from leveraging your IP against you. See China Contracts: Make Them Enforceable Or Don’t Bother. The key is early protection, when you still have leverage and before your Chinese counterparty has run off with your product, your software, your design, and/or your customers. For what you can do to protect yourself from this sort of competition, I suggest you read the following:

• China NNN Agreements
• China Product Development Agreements
• China Trademark Challenges Amid Geopolitical Uncertainties

We are also seeing an increase in Chinese companies taking foreign company money and then disappearing. For how these thefts typically go down, check out China’s Most Common Scams. The best defense against these sorts of thefts (though far from fool-proof) is to conduct due diligence on the company to which you will be sending funds. See On the IMMEDIATE Importance of China Manufacturer Due Diligence (which applies with equal force to all Chinese companies, not just manufacturers).

China’s slowing economy and its causes are increasing the risks for nearly every company that does business in or with China. Most companies realize this and seek to respond to it. Our law firm has a flat-fee package we internally call “China risks and revisions.” This package consists mostly of our analyzing a client’s China risks and then working with them to reduce those risks by fortifying that which protects them and by reducing that which puts them at risk. Our goal is to reduce the client’s China footprint and thereby reduce their China risks, while at the same time balancing that against the goal to retain all or nearly all of the benefits the client gets from doing business in or with China.

An example of this is assisting a company in exiting China, while establishing and formalizing a distribution relationship with a Chinese firm that will continue to sell the company’s products within China.

To get a sense of some of the things that determine China risks, check out How to Evaluate Your China Risks. Reducing China risks tends to be incredibly specific by industry, by company, and by what the company is doing in China. For a company that buys all its products from four suppliers in China, we might suggest it find at least one supplier outside China, and then we help them do that. See How to Move Your Manufacturing Out of China Safely. For a company in a China joint venture with ten of its own people in China, we might recommend contracts or IP registrations to protect their IP from their joint venture partner and/or we might recommend it switch from a joint venture arrangement to a distributor-distributee relationship or, to achieve an even lighter China footprint, leave the JV and license its products/technology/brand name to a Chinese company. There are all sorts of risks out there and all sorts of options for reducing them. For a company that has operations in China, our advice usually leans towards strengthening their existing legal systems, especially as relating to their relationships with their employees and other companies.

Conclusion

The risks for foreign companies that do business in or with China will remain elevated, and we should expect Chinese companies to continue acting desperately to survive, even if that means turning on partners.

Turbulence in China also has geopolitical ripples as relations with the West sour. This means every company involved with China should constantly re-evaluate its China strategy and exposure.

Follow the recommendations outlined above—strengthen your compliance and due diligence, redouble your efforts to protect your IP, and reconsider your China footprint. Keep a pulse on China’s economic situation and, in particular on your industry landscape within China. Few foreign firms are immune from the downturn. Be careful out there.