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Bad China product? Watch out if they threaten to sue you

by Dan Harris in 'China Law Blog'

Spoke the other day with a company that was contemplating suing a Chinese factory regarding bad product. This company bought about $300,000 in product that it simply cannot use. When it told its Chinese supplier of this and then held back its final ~$100,000 payment, the Chinese company said it planned to sue.

This company was referred to us by another company going through the exact same thing. Our phones are ringing off the hooks with these cases and they are not good.

Let me explain.

Chinese factories, particularly in certain industries like clothing, shoes, gifts/tchotchke, are hurting in China right now. For those of you who always angrily write me whenever I even hint at a downturn in China, I suggest you instead read this New York Times article, entitled, “In China, Sobering Signs of Slower Growth.” What this means is that many of these factories are cutting corners. Much of the bad product in these cases is not due to bad production, but rather to bad components. The factory that makes the sweaters is using lesser wool to save costs and that doesn’t work. The factory that makes the shoes is using a lower grade leather and that doesn’t work. The factory that makes the plastic toy is using a lower grade plastic. And on and on and all of this without giving any advance notice to the American buyer. Make no mistake, for the first time in a long time, quality fade seems to be on the rise in certain sectors in China.

But it gets worse.

In the old days when a Chinese factory provided bad product, they would usually eventually admit it, and blame it on either a subcontractor or a supplier. Now they deny it and threaten retribution if they are not paid whatever is still “owed” by their American buyer. I wrote about this way back in February, 2006, in a post, entitled, China OEM The Smart Way:

Good Chinese suppliers are usually very busy and they often subcontract out to lower quality suppliers. We have handled many cases for foreign companies that received bad product from their previously reliable suppliers and in well over half of these cases, the product quality problems stemmed from the supplier having subcontracted out the manufacturing. The supplier usually freely admits to having subcontracted the work and sometimes even boasts that the problems otherwise would never have occurred. The supplier admits legal responsibility for the quality control problem, but then almost always proposes remedying it by giving a small discount on future orders until the damages from the bad product have been covered. The foreign company is usually in no mood to continue doing business with the offending supplier and wants only a monetary remedy. However, because the profit margins at most Chinese manufacturers are so low, they often simply cannot pay all of the damages caused by the bad product and a standstill results that can only be resolved through litigation.

Those were the good old days.

Today, the tactic is to threaten to prevent the American company from “ever doing business in China again” or, more specifically, to seize the American company’s product at the border. We take these threats very seriously and they have altered our approach to these sorts of cases.

In the past, if an American company was seeking $200,000 in damages from a Chinese company for bad product, we would most of the time seek to dissuade them from even bothering to pursue litigation. Our thinking was that unless they had a kick-ass written (preferably in Chinese) OEM Supplier Agreement that made crystal clear the quality expectations and the penalties for not meeting those expectations, suing in China would just not be worth the time, money and hassle. And suing in the United States typically made even less sense. For an explanation as to why this is usually the case, check out “Why Suing Chinese Companies in the United States is Usually a Waste of Time” and “Suing Chinese Companies in US Courts.

But the strategy changes if the Chinese company threatens to close you down. We have dealt with cases where US companies were unable to buy from any Chinese supplier without paying 100% upfront because their alleged failure to pay had caused China’s export insurance agency to refuse to insure payments from the US company. We have also dealt with way more than our share of cases where someone or something from our client was held hostage in China to secure payment. For more on the hostage issue, check out “China Hostage Situation. Now IS A Good Time To Pay Your Debts” and “China Business. China Jails. China Hostages.

If a US company is facing the situation above, our advise is that they sue the Chinese company somewhere, usually in the United States. Being able to show the Chinese insurance company, the Chinese police, or the Chinese border patrol agents, that you have sued can be invaluable. Your complaint against the Chinese company shows that the situation is not as simple as the Chinese company is making it out to be. Your complaint shows that the Chinese company is not necessarily owed anything at all and that you are not clearly someone who does not pay your debts.

Of course, if your company has no intention of continuing to do business with China and your personnel will not be going there again, then the best strategy probably would be to just walk away, just as in the old days.

Dan Harris is founder of the Harris & Moure law firm, a boutique international law firm focusing on small and medium sized businesses that operate internationally. China is the fastest growing area for the firm. Dan writes as a source of China legal and business information.

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