China factory disputes: The 101 - Smart China Sourcing

By Dan Harris

Many China factories are in deep trouble due to declining sales stemming from the US-China Cold War. I base this not just on the economic statistics everyone is seeing, but also on the fact that our China lawyers are getting a steady stream of emails from foreign companies reporting the usual range of problems whenever China’s factories start suffering.

Our international manufacturing lawyers have been getting a ton of emails from foreign buyers that are being pursued by their Chinese factories for refusing to pay for defective products. Typically the foreign company is trying to achieve some sort of compromise while the Chinese factory is insisting on full payment.

There are a lot of huge risks for foreign companies in these situations and the typical first question we ask a company in this situation is how easily can they just up and move their manufacturing outside China. If they say they can, then we start working with them to achieve that as quickly as possible. If they cannot, we start talking about the sorts of defenses they need to start building.

There are certain things you should and should not do if you should find yourself in this sort of dispute with your Chinese factory. One thing you should not do is go to China to try to resolve the matter with your Chinese manufacturer. For why not, see Maybe Owe Money To China? Don’t Go There. Second, do not believe for even one second that your factory cares about anything other than getting the full amount of money it claims you owe it. Do not believe they care at all about having sent you unusable product. Why should they? If you don’t have a China-centric manufacturing agreement with them that clearly specifies the quality of product you are to receive, Chinese law is almost certainly on the side of your Chinese manufacturer in any event. See Overseas Manufacturing Contracts (OEM, CM and ODM) and China Manufacturing Contracts. Note that I am not saying there are no foreign companies important enough to their Chinese factories as to be able to work out a reasonable resolution with them, but I am saying that sort of situation is exceedingly rare and you should assume that is not your situation.

Truth is there is no one good way to deal with a rampaging Chinese factory and your best path will depend on your specific contracts, situation, and goals. When our international dispute resolution lawyers are retained to represent a foreign company in a dispute with a Chinese factory, they typically begin by asking our client the following questions:

Can you move all your production outside of China quickly?
How much is being claimed against you? There is no point in hiring a lawyer if the amount at stake is too low to warrant it.
Why have you not paid? This greatly influences initial strategies.
To whom do you owe the money? We usually follow up by asking how important the creditor factory is to the foreign company ’s business.
Do you have other suppliers in China in addition to the one that is claiming you owe it money? We are trying to figure out how important it is to resolve this situation quickly?
Is it important that you be able to continue doing business in China? Exactly what sort of business? These are important questions for determining strategy.
Is it important that you or anyone else in your company be able to go to China? This is an important question for determining strategy.
Do you have any brand names or logos or other IP that you use on any products or packaging made in China? If so, have you registered those brand names or logos in China? It is very common for Chinese companies to register their foreign debtor’s brand names and logos as China trademarks so as to gain leverage. Often, the first thing we do is shore up the foreign company’s IP registrations when they are in any sort of business dispute in China. You do not want to go into battle without first patching up a gaping wound. See China Trademarks: Register Yours BEFORE You Do ANYTHING Else.

What about trying to negotiate with the Chinese factory? We always want to try this because it sometimes actually works and when it does it can save the foreign company a lot of money. But if you are going to do this, you should know that if you do reach a resolution with your factory, you must document that with a signed settlement agreement that is effective and enforceable in China. It is exceedingly common for Chinese factories to agree to a lesser amount in settlement, get that lesser amount from you, and then turn around and sue you for the rest or turn the remainder owed over to Sinosure to go after you. And when I say common, I mean at least 90 percent of the time. The way to prevent this from happening is to reach oral agreement on an amount and then tell your Chinese factory that you will need it to sign a settlement agreement making clear that if you pay that amount you do not owe them anything more. About half the time they will agree to this and about half the time they will not. If they do not, that means you did not have a real agreement with them in the first place. If they do agree to sign a settlement agreement, you should then retain an experienced China attorney to draft a settlement agreement that will actually work. If your Chinese factory will not sign a settlement agreement, you don’t have much choice but to wait for Sinosure to get involved.

I will in the next few days do a follow-up to this post, outlining what Sinosure does and how you can best respond to that.

In the meantime, I suggest you read the following on how to minimize your chances of having problems with your overseas (China or anywhere else) factory in the first place.

Dan Harris is founder of the Harris Bricken 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 ChinaLawBlog.com as a source of China legal and business information.