Our China lawyers are working on a case right now that should be of great relevance for any company that buys product from China or is doing business in China. Here are the facts (slightly changed because this is still a live matter). US company goes to China and meets with company there for manufacturing product. The two parties sign an agreement and US company sends over a large sum of money to build the tooling. Chinese company then says another large sum is needed to be ready to go as soon as the tooling is complete.  Months pass. Nothing. More months pass. Nothing. It has now been a year and still nothing.

US Company contacts our law firm and wants to know about pursuing litigation against this Chinese manufacturer to recover the money paid. We determine US company has a very strong case, but suggest we first investigate the Chinese company to determine whether it has sufficient assets to pursue. We conduct a fast and cheap investigation and get a comprehensive report on the Chinese company. From this report we learn the following:

  • Chinese company is not a manufacturer. It is a trader, with a tiny, rented office.
  • Chinese company does not even have an export license. In other words, it gets its products from manufacturers and then has to bring on another company to ship them. It is just a middle-person.
  • Its only asset is a small amount of inventory, which it may or may not own.

US company decides to order a comprehensive report on ALL of the Chinese companies with which it presently conducts business.

Perhaps you should too. China due diligence. Not optional.

  • Yishi

    couldn’t agree more.
    the first training course i have ever taken since i started my career is to learn how important the dd is. as an old saying goes, you’ll gain more chances to win, if you know both yourself and the other party.
    meanwhile, the responsibility with the part of the law firm to conduct dd is also of great importance, for a dd with any fault may mislead the client. And the partner of the law firm will surely bear that damages. The largest sum of damages arising from misleading the cilent by a dd with some fatal errors i’ve ever known is nearly 0.2 billion RMB. The 3 partners of that law firm were sentenced to bear 9 million RMB.
    Ah! Therefore, it is really necessary for the law firms to take a professional liability insurance.

  • MartinW

    Yes that’s very sound advice to make sure you know exactly who you are dealing with. I guess one of the problems is that foreign companies are not always aware what company search and credit checking options are available in China.
    If you or other readers have lists of reliable and inexpensive checking services then I’m sure it is something worth sharing with everybody.

  • Yishi —
    There is due diligence and there is due diligence. Due diligence can range from someone who buys a $100 item on the internet conducting a Google search to make sure the seller has a good reputation, to the due diligence you describe, which presumably involved the purchase of a company. The thing about due diligence is that it has to be tailored to the amount at stake and the potential risk.
    What I am calling for in this post is little more than a background and credit check of those companies from whom one purchases product. The extent of those checks will usually depend on the amount at stake and the already known history of the selling company.

  • MartinW —
    Credit and background checking in China are very different from in the United States, where one can just run a Dun & Bradstreet report as an initial measure.
    The thing about China is that the investigation and report will need to vary depending on the nature of the business being conducted, the ownership structure of the company (State Owned or not) and its location. We refer our clients to many different companies in China for this sort of stuff, depending very much on the individual matter. Some of the companies to whom we refer are strictly Chinese (with no English speakers), others are more international. Sometimes all we do is make a phone call to someone we know. For example, the law firm with whom we work in Qingdao has so many maritime connections, that if we want information regarding a maritime or fishing related company in Shandong, all we need to do is call them and they will have valuable information to us within 24 hours, based purely on their own insider knowledge. We do this same sort of thing in many other industries and locations throughout China. These law firms are not in the business of giving out this information, but they do it for us because we work together.
    This is my long-winded way of saying that gathering this information in China is varied and complicated and there is nothing close to a one size fits all, or even a one size fits many.

  • MartinW —
    Credit and background checking in China is very different from in the United States, where one can just run a Dun & Bradstreet report as an initial measure.
    The thing about China is that the investigation and report will need to vary depending on the nature of the business being conducted, the ownership structure of the company (State Owned or not) and its location. We refer our clients to many different companies in China for this sort of stuff, depending very much on the individual matter. Some of the companies to whom we refer are strictly Chinese (with no English speakers), others are more international. Sometimes all we do is make a phone call to someone we know. For example, the law firm with whom we work in Qingdao has so many maritime connections, that if we want information regarding a maritime or fishing related company in Shandong, all we need to do is call them and they will have valuable information to us within 24 hours, based purely on their own insider knowledge. We do this same sort of thing in many other industries and locations throughout China. These law firms are not in the business of giving out this information, but they do it for us because we work together.
    This is my long-winded way of saying that gathering this information in China is varied and complicated and there is nothing close to a one size fits all, or even a one size fits many.

  • The importance of DD is often underestimated from a product sourcing perspective. The advent of AliBaba.com and other trading websites/portals has given those with less experience the impression that finding a credible manufacturing partner is simple, quick, and easy. I personally think visiting a factory, or any would-be overseas partner for that matter, is a necessity and often only the first step. We never work with a factory we haven’t visited. I agree with the idea that the level of dd should be commensurate with the investment. If your business’ or product’s success depends on an overseas partner–why not try and minimize the margin for error.

  • Audall —
    I completely agree with you and raise you one. Not only does it make sense to visit the factory, you must be certain that your contract is with the company that owns the factory.
    We have too many times had clients come to us thinking they had a contract with the manufacturer they met with at the factory in China, only to learn that their contract, is not with that company at all, it is with some broker in Shanghai or Hong Kong or Taiwan or wherever. This really matters when the factory gives you a million dollars of bad product and you have no recourse against anyone other than the broker with a rented office and a computer and cell phone.
    In other words, I am saying that in many instances it does make sense to hire a TRUSTED professional to assist.

  • The tricks and scams are many. I can’t imagine investing a million dollars and who knows how many man-hours in a project of that size and not doing further due diligence and consulting a trusted source to assist you. My guess is that the understanding of the risks involved are a general unknown, let alone the precautions to take.
    In general, the nature of business, government, and the legal system there is far too opaque to walk into blindly. It’s too bad too, because there are plenty of honest businessmen there doing good work, and this is often overshadowed. But if you are doing any business there of consequence to the health of your own business at home, and/or plan to be operating there for some time, why not at least check in with someone to see if there is anything you haven’t already thought of. The education alone is worth it, or maybe worth a million dollars.

  • Audall —
    Yes. A thousand times yes.