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How To Conduct China Due Diligence. Just Ask.

Posted in China Business, Legal News

Buying a Chinese company?  Looking to do a China Joint Venture?  Looking to use a Chinese company to distribute your product in China?  Licensing your technology?  Just want some good widgets from a reliable China supplier?  Everyone will tell you that before agreeing to anything you should do your due diligence to make sure that your Chinese co-party measures up.

But how do you do that, especially now when it has become clearer than ever that much private investigatory due diligence in China is illegal?

The first thing we do, because it is so easy and so cheap, is to conduct an internet search of the company in English and, more especially, in Chinese.  Doing this sort of search will virtually never be enough to feel good about going forward with a $10 million deal, but it is sometimes enough to persuade you not to do so.

Then do your due diligence the old fashioned way.  Ask your potential Chinese counter-party for relevant documents showing its various registrations and financial condition.  In particular, get its tax returns.

And if your potential counter-party will not turn over what you reasonably seek?  Seriously consider walking away. In our experience, legitimate Chinese companies do not balk at providing documents that reinforce that they are who they say they are.

And if your potential counter-party does turn over the documents you reasonably seek?  Then get someone who truly knows what he or she is doing to thoroughly review those documents.

It is that simple.

What do you think?

UPDATE:  I should have mentioned that it is even more important than ever that you hire the right firms to conduct your due diligence in China.  This means hiring a company with experience in China and, most especially, a company that knows China’s investigatory laws and follows them.

  • Kelvin

    Dan, I agree with your suggestions and this is precisely why we advocate a due diligence process that combines the use of conventional checklist and going beyond that to include idiosyncratic factors such as the founders background and relationship to identify potential red flags.

    Kelvin

  • Kent Kedl

    Dan,

    Private investigatory DD in China is not (repeat NOT) illegal! Getting information on counter parties, understanding the value chain of potency all partners, getting insight into their business practices I and market reputation in China is completely legal…and, in fact, it is ENCOURAGED by the AIC and other Chinese regulatory bodies.

    What is NOT legal is getting access to certain information, among them hukou (residential filings), bank accounts, phone records, certain asset records, etc. The “investigations” companies who have gotten on trouble with authorities here are in deep doo-doo, not because they did DD for a client, but because they did it WRONG.

    I would also disagree with your suggestion to do an internet search and then get documents from the counter party (I’ve not seen anyone here tell the truth on their taxes!) anymore than I would tell them to write a distribution agreement in their own. I’d recommend that they talk to YOU, a professional, who has seen this stuff MANY times before and knows where the bodies are buried.

    Sorry, brother…I’m usually right with you in your recommendations but I simply couldn’t let this one go without putting my two cents in.

    • http://www.chinalawblog.com/ Dan Harris

      Kent,

      I don’t disagree with you a bit. And your disagreeing with me is based more on what you thought I said than on what I did say. I did NOT say private investigatory work is illegal in China. I said that “much private investigatory” work is illegal in China. We too have yet to see anyone who told the truth on their tax returns but they can still be helpful. And note that I made clear that once garnered, they must be reviewed by someone who knows what he or she is doing. I am NOT calling for the end of private investigatory work at all and I completely agree with your suggestion that companies be sure to retain someone legitimate and experienced with China and its laws (like you and your company). So much so, in fact, that I will add that to the post. But I do think that asking for documents is important and neglected and in light of recent events, securing those documents is more important than ever.

  • Robert Walsh

    Unfortunately the kind of investigative work that is illegal now in China is -precisely- the kind that needs doing most. “Who really owns this company?” “Do they really own that swell factory I was shown, or did they just borrow it for my visit and slap their own signage on?” “How much money did they really make last year, and how much do they have in the bank?” “How much do they owe, and who do they owe it to? If I place an order and they go belly up, what happens to my downpayment?” “If individual leaders in the city government who the company claims to have in its pocket are busted, or change jobs, what are this company’s prospects?’ “How much are they really polluting?” “Do they really pay their workforce as much as they say they are, and are they compliant with all other labor laws?” “Do they really source that item from Dupont, or are they using a shoddy local supplier; how can I get a look at the real invoices?”

    These are not the kinds of things found out through superficial DD.