China international bank and factory fraud lawyersFor the last three months, our China lawyers have been confronted with a host of legal issues related to the coronavirus. This should not be surprising because China was the seminal coronavirus epicenter. For the past two months or so, our Seattle lawyers have been working on a host of legal issues related to the coronavirus. This too should not be surprising because Seattle was the initial U.S. coronavirus epicenter. For the past month or so, all this has become true for our Spain lawyers as well, as Spain too became an epicenter and a few weeks ago went into a full lockdown as well. Our Los Angeles, San Francisco and Portland lawyers have also in the past few months been hit with a slew of coronavirus related legal matters.

The coronavirus has and will continue to impact all societies and economies and this has meant our law firm has been seeing and dealing with the same sort of legal issues in all the countries in which we work. This sameness of legal issues around the world has led us to create a cross-border multi-disciplinary legal team to assist companies with their legal issues arising from or related to the coronavirus, using the knowledge and experience our lawyers have gained in one jurisdiction to determine best practices in the other jurisdictions.

In this series of posts, we’ve been discussing the legal issues our lawyers in China, the United States, and Spain have been confronting, with the goal of making this blog a repository of information on coronavirus law and especially on how to handle legal matters that have arisen due to the coronavirus.

In Part 1, we focused on employment law issues because those were the first issues we saw and those are the issues that continue to arise most often. In Part 2, we looked at force majeure “in real life.” In Part 3, a couple of our international trade lawyers analyzed how coronavirus is impacting tariffs and duties in the short term and how we see it impacting tariffs, duties and global trade in the future. In Part 4, one of our insurance coverage lawyers discussed key insurance coverage matters  stemming from COVID-19 because a massive number of companies have or will have coronavirus insurance claims and insurance coverage lawsuits. In Part 5, we discussed how the coronavirus is giving nearly free license to foreign manufacturers to provide bad product, counterfeit product, or no product at all and this is especially true of the products most needed to fight against the virus: surgical masks, N95 masks, ventilators (really anything PPE), and cleaning products and how overseas product procurement and IP have never been at greater risk. In Part 6, we discussed how the United States Trade Representative (USTR)  is seeking comments on how it could adjust or eliminate tariffs to help the United States in fighting the coronavirus. In Part 7, we discussed registering  trademarks related to the coronavirus.

In this part 8, I discuss the growing incidence of fraud being committed by companies and con artists looking to take advantage of turmoil caused by the coronavirus.

 

In addition to its impact on people, the coronavirus pandemic is impacting the health of the world’s supply chain. The resulting disorder has led to a sharp rise in commercial fraud. In some cases, the fraud is being committed by opportunists seeking to take advantage of the stress to prey on the unfortunate. In other cases, troubled factories are looking to extract final payments to try to soften the blow of their eventual demise. In either case the risk to businesses from fraud is on the rise and extreme care is required.

Below are the five major types of fraud our international lawyers are seeing in our own practices. Each fraud is based on a fake. Just as with counterfeit goods, these are counterfeit transactions. The first step is to carefully verify the transaction to spot fraud. The second step is to use what we can call the three steps for good business hygiene. First, don’t pay large advance deposits. Second, don’t pay for goods until you see the product. Inspections are difficult in this environment, but companies have to hold the line: no payments until after someone you trust has verified the product. Third, make sure you are paying the right person: no payments to bank accounts in locations not related to the parties involved in the transaction. All of these business hygiene measures are important at all times in international business. But in times like these where fraud is increasing and the ability to remedy a fraud is lessening, this basic business hygiene is essential for survival.

Here are the Five Fakes you should be most on guard against now:

1. Fake Factory. The supply chain for critical components is breaking down. Even when traditional suppliers get up and running, deliveries are delayed. So buyers are looking for alternative sources of supply. An email arrives from a new factory offering to deliver you a key product in a short period of time at an attractive price. An Internet search shows an attractive website with photos of the factory. Emails from the factory show the product in the warehouse ready to ship. To put you the buyer at the top of the queue, the factory requires immediate payment. Payment is made, and no product is delivered. When a full investigation is made (usually by the law firm you hire to try to get you your money back), the website is down, the email account is closed, the bank account of the factory is empty and the players have all disappeared. This is the classic fake factory scam and our international dispute resolution lawyers have been dealing with it for more than a decade, but never in the numbers of today.

There are several ways to spot this scam:

— Check the address. Though the website may look good, most fake factory schemes will provide for address that is a dead give away. Often, the address simply does not exist. In other cases, the address is in an improbable location. In a recent case my law firm handled worked on, the scammer had claimed to be operating a major industrial operation at an address in the downtown CBD of a major city. One look at Google Maps showed that no such factory complex existed at that location. Another time, the so-called London financial company to which one of our client was requested to send millions was a Blimpie.

— Check the bank account. Most fake factory scams will request payment be made into a bank account that has no relation to the location of the supposed factory. For example, the factory for metal castings is located in Slovenia, but the factory requires payment be made to a Cyprus bank account. Or a seafood product will be delivered from Russia, but payment is to be made to a Cayman Islands bank account. Where the location of the factory and the location of the bank are split this way, it is a very strong indicia of fraud.

— Check the history of the factory. Most fake factories don’t bother to create a business history. Usually, they will tell a story about how they have been created through the cooperation of local governments or some mysterious wealthy person as a public service. The rule here is: don’t believe the story. If the factory does not have a history that you can verify, walk away.

— Check everything else you can. If everyone else is selling the product you want for $40 but your factory is selling essentially the same thing for $20, it is probably a fraud. Many years ago we took on a case for a company that had paid $7 million for a massive amount of a particular product to be shipped via a Cambodian tanker vessel. It took us all of ten minutes to determine that there was no way the designated vessel could ship the product because it would exceed its capacity by at least double. Another case we handled involved a company supposedly based in the Marshall Islands, yet its own letterhead misspelled Marshall Islands as Marshalls Island and its phone number was in South Korea, not the Marshall Islands.

2. Fake broker. The fake factory scam has been around for a long time. A newer scam we have been seeing is the fake product broker scam. One factor holding up production of many electronic products these days is the shortage of key components. These are often lower technology “commodity” components like memory chips or circuit boards. Even when available, the lead time for these components is being substantially delayed.

In this setting, manufacturers are being contacted by component brokers claiming to have stockpiled a supply of the components. These brokers offer to deliver in two weeks rather than twelve weeks. Some of these brokers are legitimate. Some are not. For those that are not, the scheme works the same as for the fake factory. The broker requires complete payment upfront. Payment is made to an unrelated bank account. No product gets shipped and the broker disappears.

The method for avoiding this scam is similar to the method for avoiding fake factory scam: verify all the information. If it looks too good to be true, assume it is not true. Don’t pay until you have seen the goods. These rules can be hard to follow in times of desperation. But it is in times of desperation that the rules must be followed.

3. Fake company bank account/The bank switch scam. The buyer has been working with a foreign manufacturer for years. An email arrives from the factory account manager says that due to the chaos caused by the coronavirus, we are restructuring our banking relationship. From this day forward, please make all payments to our new bank account. This new bank account is located in a city with no relation to the factory: a completely different city or a different country. For example, an Osaka factory requests payments be made to a bank account in Hong Kong or Korea. The account manager for the buyer notes the request and makes payment to the new bank. But the product is not shipped. The buyer contacts the factory and the response is: “of course we have not shipped. We have not yet been paid.”

So what happened? Someone hacked the email of the factory account manager and gave instructions for payment into a bank account controlled by the hacker. Often the hacker is an employee or group of employees of the factory. An employee realizes its employer is in economic trouble and so he or she makes arrangements for payments to go into their own personal account. These payments are a bonus to be collected after the factory fails.

To avoid this type of fraud, do the following:

— Never act on an email or fax. Insist on speaking by phone with the head of accounting or the owner of the company. Don’t speak to staff: speak to someone with authority and with something to lose from a misdirected payment.

— Check the name on the bank account. If it is not EXACTLY the same as the official name of the factory, you are dealing with fraud.

— Refuse to make payments to a bank account not located in the same city as the city where the factory is located. If the factory is in Bangkok, insist on making your payments to a Bangkok bank. If the factory is in Bilbao, insist on payments to a Bilbao bank.

In our experience, the phone call method is sufficient when dealing with a privately owned factory where the owner is in direct control. These other two measures are used to deal with situations where even the owner or account manager is looking to divert funds (embezzlement) away from the factory. This type of embezzlement can occur in SOEs or public companies where the manager does not have a direct stake in the company.

4. Fake order. The factory contacts the buyer with the following story. We have been impacted by the virus forcing our factory to shut down. Now that we are up and running we are behind in deliveries and we are working three shifts to catch up. To do this, we will need to substantially increase our deliveries to you in the next quarter and so we need you to submit purchase orders in double or triple your normal quantity. But to allow us to purchase supplies and hire workers, we need you to make a substantial initial deposit of 50% of the purchase price and to secure your place in this difficult production situation, we also will need you to pay the remaining 50% prior to shipment. Since borders are closed, you will not be able to inspect at our factory. But we will send you photos confirming the status.

The buyer is desperate for the product and agrees. Payments are made, but no product is ever shipped. When no product is shipped, the buyer contacts the factory. The factory regrets its unfortunate delay and promises the shipment will go out within days. After a series of delays, the buyer eventually learns that the factory has closed its doors and the owners have disappeared.

The fake order scheme is used in situations where there is a sharp economic downturn, like RIGHT NOW. The scheme is dangerous because it is used by factory owners with which the buyer has worked for years and has grown to trust. But desperation makes even previously honest owners take desperate measures. The owner of the factory knows its factory cannot survive, so it works to collect as much money as possible to pay its workers and suppliers in-country and to provide for its own needs after the factory closes down.

So the owner contacts as many buyers as possible, pushing for inflated orders from each. The factory does not worry about its capacity to fill the orders since it has no intention of making the product. The owners feel safe from legal liability because the buyers are foreign and because it has paid everyone in its own country. They know the local government will protect them, seeing this kind of scam as self-help in a difficult situation. This is particularly true when the owner uses the funds to pay workers and suppliers.

In order for the fake order scam to succeed big, all the elements discussed above are required: inflated orders, substantial deposit, payment on shipment, no opportunity to inspect. The way to avoid the scam is then is to refuse to do business when these factors appear. Do not pay an advance deposit and don not pay for product until you have confirmed shipment through someone you trust. If you are forced to pay an advance deposit, keep that amount below 30% and assume there is a good chance you will lose it.

5. Fake product. In economic downturns, where desperate factories are unable to pull off the fake order scheme, they often resort to the fake product scheme. There are two variations on this scheme. In the first, the factory ships a worthless item instead of shipping the real product. We have seen many variations of this scheme: a container of bricks instead of electronic components, barrels of sand instead of industrial chemicals, freezer containers of what turn out to be rotten fish when thawed. In the second variation on this scheme, the product looks fine on the surface, but components have been swapped out that make the product worthless. This is particularly common for electronic products. The case for a router is beautiful, but inside the case is empty or filled with clearly substandard components that work at first but that quickly fail.

The first variation is for a factory planning to liquidate. The last set of orders is a bonus to management and key employees. If the second variation is done in a clever way, it can be difficult to discover. This variation is often used by factories that are hoping to survive by cutting costs in the short term. They assume they will lose some customers, but that other customers will take their place in a world of short supply and supply chain disruption.

For protection from the fake product scheme, use good business hygiene. Use a country-specific manufacturing contract that actually sets out exactly what it is you are to receive. Do not pay advance deposits. Do not pay for any product until after you inspect. Do not rely on in-country inspections. In the face of a major economic shock like the coronavirus, local customs officers and local inspectors cannot be relied on to verify the contents of shipments or the quality of products. Do the inspection through someone you can trust and do not make payment until after you inspect and confirm. The pressure to violate these rules will be enormous. Legitimate factories are under extreme financial pressure, meaning that in the absence of government bailouts, they need money in advance to keep their factories running. Closed borders makes inspection at the factory or the port difficult or impossible.

Conclusion

As you can see from the above, there are ways to monitor for the five major forms of fake transaction fraud. There are two steps. The first is to verify. The second is to take concrete steps to prevent the fraud from occurring.

If you fail to do the business hygiene rules I’ve set out for you above, you expose yourself to fraud. If you strictly follow these rules and refuse to pay until after you confirm, your risk goes down to nearly zero. However, in the real world of business, a company may decide that that it must break the payment rule to achieve a business objective. This is the kind of tough decision many businesses must make in the current supply chain disruption. But even in that situation, the verification and protection measures should not be skipped. Transactions must be approached with an awareness of their risks and with a plan in place to monitor those risks and to mitigate their impacts.

What are you seeing out there?