While I have only lived in China for 6 years, I have not seen suppliers and customers stir up trouble like they have so far this year.

We deal with fairly small foreign companies doing business in China and so there is a lot of selling going on.

We first sell ourselves to our clients and then we sell our clients to the factories.

This involves long discussions and pressure on MOQ’s, prices, lead times, quality standards and other factors as well.

Negotiations in China can be a tricky thing, especially when working with small and medium sized companies.

Usually these companies and the managers that we work with are very passionate about their business and their brands.

They have tight budgets and are cost conscious, but also need to protect their name brand in whatever niche they operate within.

We have worked with several small companies over the last year to negotiate with their Chinese suppliers and have also been called in to clean up after mistakes have been made.

As Dan often says at the CLB, it is always better to prepare well ahead of time rather than clean up the mess afterwards.

Recently we were working with a consumer electronics exporter; they have a nice niche carved out in their home territory and they want to keep it that way.

Our client had been asked to pay an initial deposit of 30% (fairly standard), the “agent” later claimed that the factory was in a difficult financial situation and required an additional payment to complete the order (almost double the initial deposit).

As our client needed the order quickly and had already placed the initial deposit, they visited the “agent” in the office of the sub-supplier and received promises (not written down, chopped and signed) that if they paid the additional amount that the order would be finished and shipped out on time.

Problem: the “agent” they were using ran off with a significant deposit our clients paid for an order, when they looked into the company’s registration they were quite surprised to find that the company had not been official registration since 2004. Whoops.

Getting a bit of money that you are owed from a Chinese supplier that doesn’t want to do business with you anymore is akin to a self study root canal experiment, avoid at all costs.

We contacted the sub-supplier that had actually been producing the goods for our client; they were interested in moving forward, as they would most likely increase their profit margin by working directly with the client and removing the agent/crook.

(Discussion of options in how to pursue a false agent in litigation will be coming in the next couple of weeks)

Both our client and the sub-supplier want to move forward and work together on this project, the sticky point is what to do about the old order that our client had  placed a significant deposit down for.

The sub-supplier made several claims as to why the product they had in their warehouse, with our client’s brand name, packaging and matching their order exactly was in fact property of the sub-supplier and not our client.

They claimed that part of the order (about 25%) had been seized and liquidated by the local government office of social welfare to pay back wages to the workers in the facility of the “agent”.

Interesting but not legal, they backed off of this claim when pressured.

The sub-supplier also claimed that they had only received about 10% of the initial deposit from the “agent”; this was refuted by annex-employee of the sub-supplier that our client still has a solid relationship with.

Initially, our client wanted to put legal pressure on the sub-supplier to release the finished goods that they strongly felt were the goods they had paid for.

The sub-supplier claimed that the “agent” had cost them a lot of money as well.

To summarize (and get to the point) we eventually agreed that our client would make a zero interest loan to the sub-supplier in order to finish their order and move on.

We structured two additional agreements for the client and sub-supplier to move forward:

First:

1. Our client has agreed to loan the factory XXXXX amount in order to finish their current order, the sub-supplier agrees to discount the product from the price our client was paying their previous “agent”.
   1. The factory has agreed to return loan over the next two years as long as our client;
   2. i.      Purchases at LEAST XXXXXX amount of the products in both 2011 and 2012.
      1. The factory will return 40% of the loan in the first year (2011) and 60% in the second (2012).

Second:

1. Our client wants to have exclusive distribution rights for their home territory to distribute this product, the sub-supplier must agree not to sell the specified models in these regions.
2. The factory has agreed as long as they meet the minimum yearly purchase requirements (the same as the agreed amounts in the first agreement)

Our client was very confident that he would not have a problem achieving the minimum order required but when the supplier attempted to raise the MOQ when we pressed for the exclusive distribution agreement, we pressed to keep it the same.

Do not paint yourself into a corner, make sure that any agreed to purchasing requirements are achievable and not pie-in-the sky “projections”.

While these are fairly non-traditional sales contracts, there are more details that should be specified when drafting an agreement as such.

Our contract included;

1. A physical description of the product
   1. Pictures of the products that we included in the exclusive distribution agreement
   2. The components to be used
   3. The quality of the components
   4. What testing standards you will be using to judge the quality of these components
   5. What failures will allow us to reject products
   6. What software needs to be installed
   7. What specific actions would trigger the loan repayment of the loans in both 2011 and 2012
   8. How the loan would be repaid
      1. We decided that the payments would be make as discounts for the orders once the target MOQ was achieved

Our job is to examine each and every point where we think the supplier might try and pull some shenanigans.

While you might be convinced that your supplier wants to move forward in a mutually beneficial way, be aware that pressures from a rising RMB exchange rate, rising wages and uncertainty about the global economic recovery have many suppliers very focused on short term gains.

Make sure you are getting what you pay for, our friend David Dayton at Silk Road International has been embroiled in similar face-to-face “discussions” with suppliers.

There are many potholes to be wary of, if you want to have the best chance of getting exactly what you agreed to.

Even a perfect contract in China will not guarantee success, it needs to make sense for both sides or I promise you, you will have problems.

Hong Kong is no stranger to Alternative Dispute Resolution (ADR). The Hong Kong International Arbitration Centre handled 280 cases in 2004 up to 602 cases in 2008. When foreign investors in Asia have disputes, they prefer to have a neutral “third place” for them to be settled. Hong Kong has been claimed as one of the preferred places for foreign dispute settlement, due to its developed law system and geographical location.

Practice Direction 31 (from here on referenced as PD31) for mediation, which is one method of  ADR, came into effect on 12 February 2010. PD31 is a practice direction that only pertains to the ADR method of mediation and encourages people to mediate before or during litigation procedures.

A detailed look at PD31

PD31’s main task is to encourage people to settle their disputes by making it compulsorily to consider mediation before or during litigation. While it is not “mandatory”, PD31 instructs legal representatives to inform the parties the court could issue adverse costs if they “unreasonably fail” to mediate. Unless the party has a good reason not to mediate, then they will not take on these adverse costs. Outlined by Herbert Smith LLP, we will touch on the five essential points that are particularly important when considering the new PD31 on mediation in Hong Kong.

1. Active exploration of ADR

The court has a “duty as part of active case management” to encourage other methods, such as ADR, to settle disputes. In other words, the court’s duty is to help the parties to settle matters but it is also the party’s responsibility to help facilitate these methods when ever possible.

2. Costs of unreasonably failing to mediate

When a party unreasonably fails to mediate, the court may include “adverse” costs to them. There is a minimum requirement one can participate to avoid the adverse cost, as well as having an acceptable reason why one can not mediate.  The term “unreasonable” is not clearly defined.  The best method is to go through the motions and up one mediation session. IF it does not work out, you have made you attempt. You might also resolve some issues as well.

3. Mediation procedure

Mediation certificate

The Mediation Certificate is important because it states whether the parties agree to mediate, more importantly if they do not agree to mediate, what is the explanation. The second function of this certificate is to verify if the legal representatives have explained that mediation is an option available to them, the cost of mediation compared to litigation and explaining PD31 contents.

Mediation notice

In the event one party would like to mediate, they must draft a Mediation Notice after sending the Mediation certificate. The Mediation Notice should include the party’s willingness to mediate and how to suggest how to carry out the mediation.

Mediation Response

Once the notice is received, a mediation response must be sent to the court in 14 days. In the response, it should be noted whether they agree to mediate the dispute and if not, why not.  The respondent also has the right to suggest ways of carrying out mediation.

Mediation Minute

Once an agreement is reached, it should be reduce into writing with the signatures from the parties or legal representatives. In the event the parties can not come to an agreement about mediation, for example choosing a mediator or location, they may look to the court for guidance to help solve those differences.

4. Stay of legal proceedings

At any time during litigation, the parties may opt for mediation in order to try to resolve their differences. Providing they do not conflict with any “milestone dates”, the court will allow a short break to start mediation. Milestone dates such as, case management conferences, pre trial review and trail date, stay of legal procedures will not be granted in attempt to reduce delays in court proceedings. If the parties come to agreement during the time of mediation, they will have to inform the court and formally close the proceedings. If an agreement is not reached with in that time, the previous proceedings will continue.

5. Without prejudice communication and confidentiality

One of the advantages of mediation is confidentiality. It can be a private forum between the parties, legal parties and mediator. PD31 claims the court can not compel one of these parties to divulge information to the court for evidence.

What now?

Even though mediation was available before, people might not have had the opportunity to learn about the other alternatives available to them. PD31 dictates legal counsels are to make sure their clients are aware of the advantages and cost benefits of mediation. Whether mediation is more enjoyable than litigation is not the point to be debated, but rather, PD31 requires a second option that may yield a better out come. PD31 brings awareness to this second option of mediation; an option that has always been available.

In my Chinese home town of Shenzhen, this is true like no other city.

Prices for real estate in Shenzhen have risen steadily since I arrived here over five years ago.

While prices for flats in Shenzhen are still not so close to the astronomical prices that flats in Hong Kong command, prices here do rival that of those in Beijing and Shanghai.

Shenzhen is an interesting area because of the proximity to Hong Kong and there is reason to believe that there is a significant flow on so called “hot money” from Hong Kong into China via Shenzhen.

China has taken significant steps to try to avoid the inflow of speculative money by placing tight regulations on the RMB and newer restrictions on the flow of investment capital into the country.

China’s central bank recently stated that they would begin to increase the monitoring of suspected speculative money into and out of the country.

The State administration of Foreign Exchange also announced that they would tighten the regulations on individual persons and the transferring of yuan and foreign currencies between bank accounts.

Some experts have expressed doubt that these new measures would have the desired effect on the inflow of hot money.

Because of China’s relatively low priced real estate, speculative capital will follow the old mantra, where there’s a will, there’s a way.

The problem comes into the picture when inflation begins to pressure China’s central bank and it is forced into making a decision about whether to appreciate the yuan or raise interest rates, neither of which is appealing to the Chinese central government.

The central government would be smart to encourage Chinese investors to begin to acquire more investments internationally in order to avoid the continuing growth of a potential asset bubble in some of the major Chinese cities.

While many cities in China still appear to be interesting places for speculative investment, the question of whether or not the assets are still a good value and at what point the asset bubble may burst and how Chinese investors can protect themselves.

No wonder Shenzhen has all the money in the world and won’t pay for a decent football team.

So why are international financial service companies’ not making record profits in China?

The Chinese securities market is very different from western securities markets, learning what these differences are and how they could possibly change can increase your chance for success.

This and following posts will introduce some of the barriers that foreign companies face when trying to gain entrance to the market and how the Chinese market is different from other international markets.

The biggest difference in the Chinese securities market from other markets is the amount of ownership the state has through State Owned Enterprises (SOEs).

When a Chinese SOE opens itself up to investment through an Initial Public Offering (IPO) about two thirds of the shares remain in the hands of the government through SOEs.

This creates a potential conflict of interest because the state has a vested interest in the success of its own companies, as opposed to simply being a referee that ensures fair play.

The Securities and Exchange Commission (SEC) in the has a more clear cut task of monitoring and making sure companies are in compliance with regulations, on the other hand, the Chinese Securities Regulatory Commission (CSRC) must juggle the jobs of developing state assets while at the same time avoid social instability.

This puts many investors in a difficult position, both Chinese individual investors and foreign firms looking to develop a strong Chinese portfolio.

Both of these groups are not able to purchase a majority stake holding in a Chinese company and are not able to have an active voice in the direction the company takes.

This structure encourages investors to be short sighted with their investments, to be speculative and ride the ups and downs of the market instead of finding a company that they believe in and investing for the long term.

The Chinese stock markets will not be able to escape the fluctuations that have plagued the system in recent year until they can decide the position that the state will occupy.

Playing both a regulator and a heavily invested owner in the stock market is not likely to inspire confidence in neither foreign investors nor its own citizens, but maybe thats not the point.

It was decide last week that a five year duty of 30% will be placed on the countries.

On the same day, they “slapped”  39.2% duty on steel seamless pipe  from China as well.

In a city like Shenzhen, people come and go quite often and it is nice to have a group of people from different walks of life that can get together.

Our group contains Americans, Canadians, Japanese, Chinese, Australians, French and occasionally African and Germans.

It is a great stress relieving therapy for most of us, a couple hours each week where you can run into people and talk about what frustrates us all about doing business in China.

One complaint that I hear quite often is about the lack of a legal system in China.

This is simply not the case, the system here is just very different from what most people are accustomed to in many other places.

In the US our legal system is designed to encourage its use in solving conflicts, in China the legal system is purposefully designed to dissuade you from ever setting foot in a Chinese court room.

This is the same for Chinese as any foreigner, the Chinese only use courts when there is ABSOUTLY NO OTHER CHOICE.

This quotation attributed to Emperor Kang Xi, (emphasis added)

“… those who have recourse to the tribunals should be treated without any pity, and in such a manner they shall be disgusted with law, and tremble to appear before a magistrate. …As for those who are troublesome, obstinate, and quarrelsome, let them be ruined in the law-courts – that is the justice that is due to them.”

M. Huc, The Chinese Empire (1855)

Justice can be had in China, but not through the same methods as in the west.

Choose your council wisely.

In his latest post, Over-Promise, Under-Deliver and the realities of the Chinese Market, David makes the point that

“Chinese suppliers are infamous for never saying no, believing that if there is money then they can either figure it out or sub it out.  My theory is that if the factory is so honest that they’re willing to lose business by telling me ‘no’ then that’s someone I want to work with in the future.”

I had a recent run in with this same situation last month for an LED project I was working on.

I attended an LED show in Dongguan, at possibly the worst Sheraton in China, and was able to use my foreigner pass to be seated as a foreign buyer, which I guess is technically true.

I did not know much about LED’s but I was armed with my client’s specs and ready to take on all comers.

I was taken aback because the first couple of suppliers, with rather large factories and extensive manufacturing capabilities, told me “No, we can’t do that.”

I was told that reaching 2 of the 3 specs was doable, but they couldn’t hit everything I wanted.

Then I had several smaller companies tell me “Sure, we can do that no problem.”, now back in my early China days I would have jumped at these offers but now that I’m no longer a China virgin, something seemed fishy.

I went back to my client and told him what I had heard from suppliers and he admitted that he was testing my ability to find accurate suppliers and that their specs were not something widely available.

The first factories I contacted were the ones that originally told me “No, we can’t do that.”

If you are lucky enough to find an honest supplier like that, WORK WITH THEM.

Two months ago I talked a little about a new online database that can help you investigate companies within China that have a record in the court system. You can find that here. What this record details is the company’s delinquency on a judgment from a court. For example, company A was ordered by the court to pay company B but has not paid company B.

A good friend, Seth Buckley, wrote a piece about the Judgment debtor system and is featured in China Law and Practice . It is titled Nowhere to hide and explains how the online Judgment debtor system can be used for your due diligence in China.

Seth writes:

The primary purpose of the new database system is to increase compliance with executable judgments issued by Chinese courts, a task that has been notoriously difficult in China. As well as providing critical information for due diligence evaluations, the database uses potential reputational loss to pressure the debtor into satisfying its obligations and the courts into facilitating debt collection…

…Companies can now incorporate this information into their due diligence analysis and perform a more meticulous evaluation of an entity’s financial stability. This can be critical for determining a potential business partner’s dependability in commercial contracts, as well as for evaluating target companies for mergers and acquisitions.

The database could thus potentially affect a debtor’s reputation as a desirable future business partner. This will give debtors greater incentive to settle their debts in order to protect future interests.

Seth really brings the point home, make this step apart of your due diligence. If you’re going to do a project here in China and using a considerable amount of your funds, confirm the reputation of the company. The last place you want to be is at the other end of the proverbial stick with a company that does not make good on its responsibilities.

If you would like to read Seth’s complete article, you may sign up to China Law and Practice for a free trial. To have a look at the database (all in Chinese) look here . If you guys have any questions on the database, send me a comment.

Last week I posted a small article to emphasize the importance of Labor contracts and conditions. Whether you are an employer or employee, it is important to understand how to protect your interests. This week I will post a series of labor cases to show how they came out and where people went wrong. Here is a recent case I have reviewed to illustrate the importance of:

-Having a contract

-Having a work permit

-Know what rights you have

So, let’s start with the American

All foreigners are required to apply for a Work Permit for Foreigners if they want work in China. “Jack”, an American, failed to renew his work permit. Later, in no connection, the company he worked for removed him from his position as executive director, legal representative and general manager. “Jack” then leaves the company on May 12^th 2008.  “Jack” sues the company for back wages and “deprivation of his labor right and labor condition”. The fact is, the company had never signed a labor contract with him.

Since he did not have a labor contract, he could not be seen by the arbitration committee, which deals with employment disputes. He then filed a law suit and claimed he was owed:

- A labor contract to be signed and continue to be performed

- To repay back his expenses

- Pay double salary for the period the contract was not signed (2006 to 2008, laughable this guy)

The court ruled, in order to be protected by labor laws, all foreigners are required to apply for a Work Permit for Foreigners if they want work in China. He was not qualified to work in China and by working for the company; he had violated laws regulating employment of foreigners. “Jack” had no labor rights. They did say since he left on May 12th, 2008 he should get payment for 12 days salary and all other claims were denied.

How is your employment contract looking?

Employers almost certain to lose at China labour tribunals

June, 2009

www.chinalawandpractice.com

Employees are winning almost all unfair dismissal cases at labour tribunals across mainland China, and there may be political considerations in play.

The PRC Employment Contract Law, which took effect on January 1 2008, introduced the right to low-cost labour arbitration. Since then, there has been a dramatic rise in the number of cases handled by labour tribunals.

“What this means is that the arbitrators may be less likely to spend the time considering the legal merits and in our experience will be much more inclined to try to help the parties negotiate a quick settlement,” said Joseph Deng, special counsel with Baker & McKenzie in Beijing, during a China Law & Practice web-seminar held on June 25.

“In terms of the bottom line for an employer, your highest risk will be if you have to terminate an employee and do not have a perfectly legal way to do it,” he said.

A recording of the entire 60-minute web-seminar, entitled Working with the Employment Contract Law, is available online at www.chinalawandpractice.com/webseminars