It is becoming increasingly easy to blame the “victim” of China business disasters. In my experience, when bad things happen to good people who do business in China, it is nearly always the “good” person’s fault. Like many lawyers who work with China, I have a ready set of horror stories to illustrate this phenomenon:
- A person “invested” $500,000 into a Chinese business because the owner was allegedly the son of a five-star general. A lawyer at my firm suggested that this investor instead go to Las Vegas and “put all the money on red.” As the lawyer put it, the chances of the investor recovering his money in Vegas were much greater. Despite our warnings, this person proceeded to invest the $500,000 and, unsurprisingly, lost every bit of it. He then wanted our firm to sue the “son of the general” on a contingency fee basis. We declined.
- Another “victim” bought a million-dollar condo in Shanghai under his girlfriend’s name because he believed that foreigners were not allowed to own real property in China. His girlfriend then left him and claimed he had given her the condo as a gift. He wanted us to sue the girlfriend but my firm demurred. We just did not like a case in which our client would need to explain to a Chinese judge that he had put the condo in his girlfriend’s name in order to circumvent what he believed was Chinese law. Had this foreigner done his research, he would have known that he could in fact have purchased the condo in his own name. His girlfriend had lied to him about Chinese real property ownership laws.
- Countless people call my firm after having sent tens of thousands of dollars (sometimes hundreds of thousands) to China for a product that never arrived. Eventually the person and “company” to whom they sent the money disappear altogether. We have never taken one of these cases because of their utter futility.
- A US company used its joint venture partner’s local Chinese lawyer, who drafted up blatantly lopsided agreements. Pursuant to those agreements, the American company would permanently surrender its critical technology to the joint venture, without getting any real influence or control in it. This is an amalgamation of probably half a dozen poorly formed joint ventures for which my firm has been enlisted.
My colleagues and I can recount many more such tales with similar outcomes. This alarming pattern begs the question: What can a foreign investor do to protect its China investment? There are plenty of precautions one can and should take before jumping on the China investment bandwagon, such as the following:
- Investigate how other Chinese companies perceive the Chinese company in whom you are interested. Talk with the company’s competitors, vendors, and customers. If the company has no such vendors or customers, that fact speaks for itself.
- In a country where managers often earn less than USD$1000 per month, it is neither unusual nor difficult for an unscrupulous company to buy someone’s loyalty for the duration of a meeting or a phone call. Assume anyone with whom the Chinese company puts you in touch is in the pocket of the Chinese company. Use your own networks to research the company and industry.
- Ask yourself how the Chinese company might have staged everything you have seen, done, or been told by the Chinese company. Do you know for certain that the person with whom you just spoke is a customer of the Chinese company? Do you know for certain if the Chinese company really owns the factory you just toured? Does the Chinese company really make the products it claims it makes or did it just buy them from another factory? Does the person who is leading you around the site really own or even work for the company?
- If you come across something unusual that the Chinese company is doing, do not move forward until you are satisfied with its explanation. Do not do business with a Chinese company that is doing something that defies common sense. If the company is claiming to be a big seller of a particular product, but nobody who buys that product has ever heard of the company, ask why. If the company claims to be a thriving international company and yet uses a two person accounting firm, ask why. If the company claims it is registered somewhere but you cannot find the registration, ask why. Just because your Chinese partner and/or your Chinese partner’s lawyer tell you “this is how things are in China” does not mean you have to believe them, and it certainly does not mean you have to abandon your common sense.
- Do not hire someone fresh to conduct your due diligence for you as that person may end up getting paid by the Chinese company to give you a whitewashed report. At least half the time when my law firm is brought into a fraud situation it is instantly apparent that a “trusted subordinate” was either incredibly stupid or, more likely, in on the fraud.
- It almost always pays to look closely at the company operations yourself. Go to the company’s factory or office. Use your visit to determine how much material is moving into and out of the factory. Are the people in the office actually doing more than just acting as props? Ask the security guard how long the company has been in the building. It is important that you visit more than once and at least one of your visits be unannounced. We had one client who visited a Chinese factory a second time to find that the machinery from his first visit had vanished.
- There is probably no document that has not been faked thousands of times in China. I have seen fake bills of lading, fake bank statements, fake contracts, fake purchase orders, fake company registrations, fake IP registrations, even fake lawyers. If you are going to rely on paper, at least do more than just rely on the document itself. At minimum, check with the company or the governmental body that purportedly issued it..
- Put all of the documents you receive under a microscope. Even the most experienced scammers nearly always make some mistake in their fake documents. In my career, I have caught the following red flags in the paperwork:
- A company that claimed to have a multi-million dollar account at a non-existent bank.
- A company that claimed to have a thriving subsidiary in the Marshall Islands, yet always spelled the country as “Marshal Island.” It had no such subsidiary.
- A company that claimed to have a branch office in a particular city, but placed that city in the wrong province in its documents. It had no such branch office.
- A company that claimed to be bringing in twice as much product as physically possible on a particular ship.
- A company that claimed to have been shipping out product on a particular ship that did not exist during the first few years when the product was allegedly being shipped.
- A company that claimed to have won an IP lawsuit in a country’s supreme court (it even produced the court’s decision), but there had never been such a case.
Before you do business with a Chinese company, try to get the company’s official corporate records from the official Chinese government sources. Though doing this is neither inexpensive nor easy (and it has gotten considerably more difficult in just the last year), it can be incredibly enlightening in that it usually goes far beyond the information provided by the basic company search firms. The China company search firms typically provide only a basic list of information, such as the names and addresses of those involved with the company and its registered capital. The information from these search firms is also of dubious provenance. How did they get the information? Can you be sure they looked at the entire file? Since the files are only supposed to be open to lawyers, how did they obtain access? Because the previous year’s documents may not be helpful, how recent are the documents they reviewed?
Most China business disasters can be avoided by giving your China investment its due diligence. Following this advice will not guarantee a wise investment, but it will certainly improve your odds.
What do you think?