In part IV of our continuing series on the end of cheap China and the impacts arising from that, co-blogger Steve Dickinson wrote about the increased risks product buyers are facing from their China-based manufacturers. That post concluded with Steve talking about why paying your Chinese manufacturer in advance for product can be so risky. In this post, Steve addresses other, better, payment options. 

To summarize my last post (The End Of Cheap China, Part IV. More On How YOU Must Prepare For It), the following are the basic rules you should employ to pay for product produced by Chinese manufacturers:

  • Avoid paying an advance deposit. If you must pay an advance deposit, understand the risk. Do not throw good money after bad in sticking with a manufacturer that shows it cannot do the job.
  • Inspect the product before you pay. Ideally, do the inspection after delivery. If you inspect the product in China, take into account the risk of deception.
  • Take your inspection seriously. If the inspection shows a problem, either cancel the contract or insist on a remedy. It is surprising how many buyers ignore the results of their own inspection. I have seen several cases recently where buyers contracted for OEM manufacturing of their product using the terrible 30/70 system discussed above. Having read about the problems of defects from China, they paid for a pre-shipment inspection. The inspection showed numerous surface defects, suggesting deeper problems with the product. However, as a result of feeling stuck by their deposit and being under time pressures, they paid the full amount and had the product shipped anyway. In each case, numerous defects appeared, rendering the entire shipment essentially worthless. They could have filed suit in China, but either the amount did not justify the cost of suit or they did not have the resources to sue. If your product inspection reveals a problem, take this seriously. Do not payuntil the problem is solved. Do not think that a theoretical right to sue will save you from disaster. International litigation is expensive and uncertain. Do not allow yourself to be put in a position where such litigation is even a possibility.

The above discussion shows how truly unusual the situation is in China concerning product sale. For most countries in the world, the standard product purchase and sale contract is something like this:

  • Payment is made after inspection. In most cases, the inspection is made in the country of delivery to prevent fraudulent substitution.
  • Inspection is made by a truly independent and expert inspector. The inspector usually works for an internationally recognized inspection agency with a long track record of expertise and independence.
  • Payment is made pursuant to an irrevocable letter of credit issued or confirmed by a major international bank.

The key to this system is the participation of truly independent, trusted intermediaries: the inspector and/or the bank. In drafting purchase agreements where such trusted intermediaries will be used, I focus far less on the litigation/ dispute resolution process because my client’s protection comes from the payment system itself. I Instead focus on creating a set of clear rules so that the intermediaries will be able to do their job with no chance of mistake or misunderstanding. If my drafting is unclear, the inspector or bank will simply reject and I have to try again.

The situation in China is oftentimes completely different. In the China trade process, the usual trusted intermediaries are not permitted to operate. Inspections are done by state owned inspection companies. Letters of credit are issued by state owned banks. Since the 80s, these state owned entities have shown that they are not independent. They will virtually always side with the Chinese side in the case of a dispute.

The result is that they are seldom used. Without the services of trusted intermediaries, the Chinese trade system is set up so that one side of the transaction bears excessive risk. In smaller transactions, the foreign buyer usually bears the risk. In large transactions, the Chinese seller usually bears the risk. This would not be necessary if the Chinese companies and government simply made greater use of the existing system of well established inspection and trade finance.

However, I see no movement at all in this direction. The risk is considerable and must be taken into account in all purchases from China.

Buyer beware.

DAN’S ADDITION: Many years ago, I represented a US Company that was sued for having provided allegedly rotten food to a foreign fish buyer. The foreign company sued my client in a US Federal Court for the bad food. The foreign company’s case hinged entirely on a Chinese government inspection of the fish, which said that the food was bad. Very soon after the case was filed, we told the foreign company plaintiff that there would be no way it could prevail because the Chinese government inspectors would never testify and without them, they had no evidence of bad product. Two years later, and right before trial, we settled the case for a pittance because the Chinese government inspectors had avoided being deposed and would not be showing up for trial. I mention this to point out that even in those cases where the Chinese government inspection reveals bad product, you may not be able to use that inspection in such a way to ensure a real recovery. This case was maybe five years ago and things may have changed since then, but I doubt it.