China scam

Over the last couple months our China lawyers have seen a massive increase in emails and phone calls from companies (mostly U.S. but with a much larger percentage of Mexican and European than in the past) telling us they’ve been scammed or seeking our assistance in determining whether they are about to get scammed. And when I say “massive increase,” I mean we are seeing probably five to ten times the number we usually see. Does anyone know why this might be the case?

Anyway, in recognition of this recent increase in scamming, I am going to write (again) about the sorts of scams we usually see, along with providing tips on how to avoid them.

I cannot help but start out with what may just be the oldest scams out there and one that is roaring its ugly head with a vengeance again: the “you need to come to China to sign the contract or for a signing ceremony scam.”  This scam has been around forever and yet Western companies still fall for it.

The scam consists of the Chinese company (actually, in every instance when our firm has done any investigation at all we immediately learn there is actually no real Chinese company there) luring the Western company in with promises of big money for services (or sometimes products) to be supplied by the Western company. There is just one small hitch: the Western company must go to China, virtually always to some tiny village in China, (never Beijing or Shanghai or Shenzhen, or even Tianjin or Qingdao) to sign the contract. The last two I saw (both from yesterday) were in villages of 20,000 and 80,000 people.

Why must the Western company go to China to sign a contract when business with Chinese companies constantly gets done without an in-person signing? The following are the reasons usually provided:

  1. Chinese custom. It would be rude if you don’t come. Note that of the thousands of China contracts in which my law firm has been involved, maybe around two percent have involved in-person signings and all (or at least most) of those were because our client finalized the agreement with the Chinese company while it had its personnel already in China, have either been either huge, or have required the foreign company to get to work in China pretty much immediately thereafter or
  2. We need to do this in front of Chinese government officials, for one reason or another. Note that I can recall only two instances where our contracts were signed in front of government officials and those didn’t need to be. They just were because the transactions were so large and so vital to the local economy and doing so was a way of improving government relations going forward.
  3. The contracts need to be notarized by a Chinese notary and for that they need to be signed in front of a Chinese notary. Complete lie.

Why does the Chinese company want the Western company to go to China? How does the Chinese company possible benefit from this? Based on the Western companies that report back to us after they have been scammed, the following are the most common:

  1. Western company personnel will be put up in a local hotel for 4-5 days and the bill will be maybe ten times what it should have been. The hotel and the scammers then split the take. This is not to mention the multiple celebratory banquets that also are grossly over-billed and paid for by the foreign company.
  2. The fake notary charges a percentage of the deal, typically USD$8,000 to $15,000. The Western company believes it must pay this for the deal to go through.
  3. The Western company is subtly told that for the deal to go through, government officials must be paid and it is legal for a foreign company to pay them. Complete lie. If these were really government officials and you do really pay them, you are risking jail time in both China and most likely in your home country as well.
  4. Some third party is necessary for the deal for some reason and the Western company must pay that third party. Really?

For more on this particular scam, check out Ancient China Business Scam With A New Hollywood Twist and Ancient Chinese Business Scam With A New Hollywood Twist, Part 2.

How do you prevent this scam from happening to you? Easy. You conduct basic due diligence on the Chinese company before you get on the airplane. Long before. The first thing you do is determine whether your China counter-party even exists as a registered China company or not and if by some small feat it does actually exist, you make sure it can actually conduct the business it is seeking to do with you. And when you discover that it doesn’t, you end all communications.You have been warned.

Again.

Innovation race

This is Part 2 in what will be a long-running series by Scott Holbrook and Adam-Paul Smolak on how the United States and the rest of the world can take back much of the manufacturing they sent to China and thereby bring high-level manufacturing jobs to the United States and to allied countries. Go here for Part 1, China and the Future of American Jobs.

 

— By Scott Holbrook and Adam-Paul Smolak

THE US-CHINA COLD WAR NOW, THE EU-CHINA COLD WAR LATER

China and America are in a Cold War and innovation is the new Arms Race.

This can be seen by the nearly unlimited government resources China has put into areas where the United States (and to a somewhat lesser extent, the EU and Japan and a few others) have traditionally been the world leaders: Electronic Communications and Software, Space Exploration, Military Weapons, Energy and Biometrics. China’s actions to dominate the world in these areas include the following:

  • Decades of technological espionage
  • Installing global 5G networks by, among other things, using government subsidies to undercut pricing
  • Creating Beidou, the Chinese competitor to GPS
  • Launching a Mars rover mission
  • Developing electric vehicles (EVs) and Green Energy, with the benefit of government subsidies and few safety regulations
  • Developing A2/AD missile capabilities
  • Developing genetics and DNA identification techniques, with the benefit of government subsidies and minimal ethical or safety restrictions
  • Developing a COVID-19 vaccination, with the benefit of government subsidies and minimal ethical or safety restrictions
  • Using its Belt and Road initiative to expand its geopolitical footprint, entrench itself in the domestic affairs of member countries, and expand development and usage of its technology and military capabilities

In China Doubles Down on Industry Subsidies: No Exit, this blog described how China government subsidies are at the core of its efforts and at the center of its “Made in China 2025” Initiative:

After the trade talks with China broke down, the PRC government immediately announced measures designed to support the development of Chinese semiconductor manufacturing. On May 8, 2019, the [China] State Council under the guidance of Li Keqiang announced it would extend a long-standing series of Chinese government policies supporting development of the domestic PRC chipmaking capabilities. This group of policies is just the type of Made in China 2025 subsidy measures that have been at the core of the U.S. dispute with China. In fact, it has been reported that failure to resolve the subsidy issue is the primary reason the trade agreement collapsed. See Trade talks face moment of truth as US pushes China on subsidies: Beijing’s state support for core industries remain as sticking point in negotiations. So in other words, in response to U.S. complaints, China decided immediately to report that it would go full speed ahead on a collision course with the U.S.

To clarify, chip promotion policies are typical of the Made in China 2025 program. There are three core elements, all of which critics of China deem unacceptable:

1. Chinese chipmakers receive a tax benefit. The basic plan for general chipmakers is no taxes for 2 years and a 50% reduction for 3 years. For chipmakers that can break the 9 nanometer barrier, there will be no taxes for 5 years and a 50% reduction for 5 more years. This plan was initiated in 2011 in the (国务院关于印发进一步鼓励软件产业和集成电路产业发展若干政策的通知) here. The State Council apparently plans to extend the benefits of this old plan.

2. Creation of the government controlled and funded China National Integrated Circuit Industry Investment Fund (国家集成电路产业投资基金) under the lead of CBD Capital, a wholly owned subsidiary of China Development Bank. The plan of the fund is to invest billions in chip manufacturing R&D and manufacturing capacity. This fund was created in 2014 and it did a second round of fundraising in 2018. See China invites overseas investors to propel local chip ambitions.

3. Overal planning and control exercised by the central government. This plan is outlined in the State Council Guideline for the Promotion of the Development of the National Integrated Circuit Industry which was issued in 2014.

As you can see, The PRC semiconductor program is a textbook case of all the U.S. finds objectionable with China’ high tech industrial policy: central government direction and control, subsidies in the form of tax breaks and funding from central government sources (funding with “strings attached”).

What this means is that in the face of the failure of the trade negotiations and the subsequent Huawei Entity List sales ban, the PRC has “doubled down” on its Made in China 2025 subsidy program. Not only will the PRC not back down on the subsidy program, the notice from the State Council makes clear China will in fact redouble its efforts to ensure that the program meets its intended goal. This basic policy position was made clear in a recent announcement from Wang Zhijun of the Ministry of Industry and Information Technology (MIIT). Wang announced that the Chinese government will continue its support of its domestic chip industry and will expand that support to software and the high tech sectors. Mr. Wang announced that China welcomes the Huawei ban as a push from the U.S. on reviving the chip design and production program: “To offset the possible implications of the ban, the ministry said it would this year introduce a two-year waiver on corporate tax payments for software developers and integrated circuit manufacturers, and reduce the rate on subsequent payments to 12.5 per cent over the next three years.”

As the South China Morning Post concluded after reporting the comments of Mr. Wang, “Beijing’s role within Chinese industry, in particular its financial support for the state sector, has been a major sticking point in the trade negotiations between the world’s two largest economies. Washington complains it puts US companies at a disadvantage, but Beijing says the matter is one of principle and it has no plans to change.”

China’s heavily subsidized approach to dominating various critical global industries is a symptom of the world’s “fundamentally failed approach to China.”

The failed approach is the idea that after its accession to the WTO, the PRC would gradually transform into an open, market oriented system along the lines of the U.S., Europe and Japan. The policy is what the Germans (and much of the EU as well) call “change through trade.” See EU’s China policy is no longer just carrots. That policy failed. That failure is permanent. Ten years ago, many believed China would change. Few believe that now and that is why so many who have dealt with China for 10+ years are so frustrated. Fool me once….

The proper way to look at China is the approach taken by German industry in its recent report on China issued in January, 2019.  In the Report, China is identified as “systemic competitor” to the open market economies. As the Report states:

For a long time it looked as if China would gradually move towards the liberal, open market economies of the West by integrating into the world economy and reshaping its economic system. This theory of convergence is no longer tenable. China is no longer developing structurally in the direction of a market economy and liberalism but is in the process of consolidating its own political, economic and social model. At the same time, China as an emerging economic power is shaping other markets and the international economic order. The Chinese model of an economy marked by substantial state control thus enters into systemic competition with liberal market economies.

The Report concludes that China has developed an integrated set of policies in direct opposition to and competition with the liberal open market system. Countries with open market systems must deal with China’s policies as they are and without any hope those policies will change. This characterization of China a systemic threat is a remarkable change for German industry which had until 2019 been reluctant to speak out against the Chinese system. See Germany Industry Comes Clean on China  

Though China has mostly failed to develop at anything beyond a fairly low level most of the industries it has been heavily subsidizing and for which it has been stealing IP, it has no intention of of ending either of these programs that so offends a large part of the world:

Stated bluntly, China is reviving a set of policies that completely failed. As James Lewis bluntly stated in a recent report, “despite 40 years of effort, investment, and espionage, China is unable to make advanced semiconductors.”(See China’s Pursuit of Semiconductor Independence. The tax breaks were a scam, as they always are in China. The chip fund investments, if they were made, were a waste of money. The brutal fact faced by the State Council and the MIIT is that China has made no meaningful progress on chip manufacturing over the past two decades. China makes cheap memory chips, but sophisticated chips still come from Taiwan. China has made little to no progress on chip design. Without design technology from ARM and testing technology from various U.S. companies, no Chinese entity (Huawei included) has any real hope of building a new advanced chip. China is stuck with bulk memory chips or copies of foreign designs. .

The whole policy has been a colossal failure and the Chinese authorities know this. The reports of revived and redoubled efforts are typical of the Chinese bureaucracy: don’t worry, we will do it right THIS TIME. But they won’t. So we should view the PRC for how Germany describes it and how pretty much everyone in the semiconductor industry sees it: a systemic competitor that cannot compete in the world of high technology. Low end, low margin, high volume manufacturing is the world from which China seeks to escape. Nothing from its recent announcements (or the realities on the ground) suggests this escape will ever occur. This means that as the U.S. accelerates cutting Chinese companies off from U.S. technology, the impacts will be far more severe than is generally understood. The Chinese authorities know this. But they are in a box from which there is No Exit.

Like it or not the Cold War between the United States and China (and soon Europe and China as well) is here and if you are not already looking to have your products made somewhere other than China — might we suggest Thailand or Vietnam or Taiwan or Mexico or the Philippines or Indonesia or wherever — you should start. See The US-China Cold War Starts Now: What You Must do to Prepare.

Though China is dead set on winning the innovation race, few Americans yet know we are in a new Cold War with China that will likely soon include the EU against China as well. However, Americans are beginning to awaken to the crisis, due largely to recent event involving China, such as all that happened in just this past week:

 

NECESSITY IS THE MOTHER OF INVENTION/INNOVATION 

First, “Innovation” is more than a buzzword to Americans. It’s deeply tied to the self-reliance internalized by early settlers. Self-reliance and innovation were necessary for survival. It is a way of life ingrained into America’s DNA before there even was a United States. Innovate or die.

This same sense of self-reliance inspired Thoreau to live at Walden Pond for two years and write his magnum opus, Walden. This mixture of self-reliance and innovation was responsible for Thoreau experimenting with different ways to measure the depth and shape of the bottom of the supposedly “bottomless pond.” It was this self-reliance that led the Wright Brothers, whose lack of a university education “and little money never stopped them in their mission to take to the air. Nothing did, not even the self-evident reality that every time they took off, they risked being killed.” We could go on and on describing similar such American inventors, but suffice it to say that this streak of innovation still runs strong today. That is why the quintessential American “homestead” includes a workshop/shed/garage or some place where tools are stored and artifacts are built. Everyday, Americans put their self-reliance and innovation to work in these home-based workshops where they “tinker” and build solutions to problems they face in the course of their everyday lives.

DIVERSITY IS KEY  

Second, a key component of innovation is having access to the problems you are innovating to solve. This means users and manufacturers need to be able to work together to innovate new products or processes. This feedback loop is critical.

Diversity is one of America’s core strengths. Ethnic diversity, racial diversity, religious diversity, diversity of activities, diversity of cultures and views. China is far more homogeneous, especially in its most developed regions. The United States (despite Trump’s anti-immigration push) pulls in the best and the brightest from all over the world. “More than half of the top American tech companies were founded by immigrants or the children of immigrants.” Apple, Amazon, Google, and Facebook were all founded by first or second generation immigrants. Add in that Microsoft CEO Satya Nadella comes from India and one can quickly see that America’s largest and most influential tech companies (with a combined market capitalization of nearly $7 trillion) all are where they are due in large part to immigrants. How many non-Hans can you name in any true leadership role in China?

What this means on a practical level is there is more opportunity for innovation in America than China. Every ethnicity, activity, culture, view, etc. represents an opportunity to innovate China lacks. All of these American tech companies have employees from at least 150 different countries. If any need help figuring out how to localize a product for Ethiopia, Egypt or the Ukraine, they can tap in-house employees for assistance. If any need help figuring out what Jordan, Ghana or Portugal need, they can tap in-house assistance. If any need help in buying a business in Ireland, or Kenya or Mexico that is developing cutting edge products, they can tap in-house assistance. The closest China comes to doing the same is sending its best and brightest to be educated overseas and even that is being restricted.

 

THE NEED FOR SPEED

Third, accelerated innovation requires accelerated design processes and product cycles — from ideation to prototyping to the final commercial product.

Chinese factories take months to develop new products. Jigs must be designed, tools must be built and machinery must be calibrated. The prototype then must be taken to the field for use — which is usually not in China. Then feedback must be relayed between three or more parties. And any changes usually require new jigs, new tools and new calibrations. The whole process is time-consuming and expensive because it’s not what Chinese manufacturing was set up to do.

Manufacturing in China has been optimized to take advantage of certain elements present in China that America lacks. Massive amounts of cheap labor, a lack of rigorous safety and pollution laws, homogeneity throughout the society and an aversion to creativity. Perfectly suited to mass producing widgets based on designs provided by others. Innovating under such conditions is mostly detrimental to the process.

 

AMERICA’S HEAD START 

Fourth,  America already has the “bones” required for immediate feedback loops, drastically shortened design processes and simplified supply chains.

Companies like Stratasys have been working with American manufacturers for years to help them implement advanced manufacturing tools and techniques in their operations. Using tools like 3D printers, companies such as GM, Ford, Lockheed Martin and others have been able to reduce production costs in half, while simultaneously reducing the time required for prototyping from months to days, sometimes hours. Imagine being able to create and test three prototypes/week. This is not happening in China.

In addition to rapid prototyping, American companies are almost invariably better at controlling inventory than Chinese companies.  For example, if an American company finds a defect in a product it manufacturers, it is far less likely to be stuck with tens of thousands of products of dead inventory. This ability to produce products and components according to need (rather than per a Chinese MOQ), allows companies to save money, thereby increasing the resources available for innovation projects.

 

AN UPHILL BATTLE — INNOVATION AND COMMERCIALIZATION 

China did not want an innovation war with the United States this soon; it would have preferred to wait another five to ten years, but that war started early. Nonetheless if the United States does not move quickly and with alacrity and with cooperation from allies to utilize the advantages it possesses, it will not necessarily win this war.

Even if China cannot win the innovation battle it can do enough to win the commercialization battle and here is how, in three steps, China could make that work.

Step One: Convince the West to keep transferring its technology to China and allow what is not transferred voluntarily to be stolen.

Step Two: Allow China to continue using its standard technique of commercializing technology within its closed market, free of foreign competition.

Step Three: After perfecting commercial applications in China, sell the commercialized product back to the West at a subsidized price. If the West won’t buy from China (unlikely absent legislation or tariffs/duties), sell to the captive countries in the Shanghai Cooperation Organization and to Belt and Road countries.

In other words, China will win the commercialization battle if the West continues to support China’s system with tech transfers and funding. This is an international issue: action by the U.S. is not enough. More deeply, it is fairly certain China can win the innovation battle with Step Three alone. In very basic terms, even if China’s product is one generation behind, if it is “good enough” and subsidized enough to be 30% to 50% cheaper, then for most of the world, China will prevail.

Rational Western government policy needs three parts: One, support for Western innovation. Two, Positive action to neutralize China’ commercialization advantage. And three, international support to shut down China’s commercialization advantage.

China will not change so Western measures must assume no change and involve direct action. No tech transfers to China. No transfers of capital to China. No China contract manufacturing. No purchasing of any Chinese made product that incorporates critical technologies. This only works if done on an international basis. Ramping up U.S. competitiveness within the U.S. is essential for beating China head to head, but it will be difficult to prevail under this strategy if we continue to transfer tech and capital to China and to the other members of the SCO and the Belt and Road.

In our next post we will take a deeper look at what advanced manufacturing is, why it is perfectly suited to the American way of life and business, and the resources already available to companies that wish to reduce their dependance on a China so filled with risk. See Has Sourcing Product From China Become TOO Risky? and The Top 14 China Wild Cards/Future Risks.

 

Scott Holbrook and Adam-Paul Smolak together operate a number of product and manufacturing companies and they both have a long history assisting educational institutions in developing and enhancing manufacturing and logistics programs and events.

Free Product from China

Every day for the last week I have gotten at least one email from a foreign company that paid money to a company in China and got literally nothing in return. The term for this is theft.

This sort of thing is a given by Chinese companies and for why this is so prevalent lately and what you can do to protect against this, check out  China Manufacturing Risks are Sky-High Right Now. Act Accordingly. We write about these risks often here, but that is not the topic of today’s post.

Today’s post is about the flip side. Today’s post is about foreign companies that get product from China and do not pay for it. How do these companies accomplish this and how common is this?

My law firm’s manufacturing and litigation lawyers actually see the flip side of this quite often as well, but more like once or twice a month, though these numbers seem to be rapidly increasing as well. And virtually all of what we see has not been planned. It is something that happens when the foreign company encounters financial difficulties that make paying its Chinese counter-party difficult or impossible or when there is a dispute regarding the quality of what the Chinese counter-party was to have provided — usually a manufactured product. What happens in these situations?

Not paying Chinese companies and getting away with it is actually quite easy. And when I say easy, I mean that of the 25+ times the international litigators at my law firm have represented foreign companies on such matters against Chinese manufacturers or against Sinosure (China’s government-owned export insurance company), not one single time has the Chinese company or Sinosure ever actually sued our client. Not once.

Why are Chinese companies so reluctant to sue foreign companies that do not pay for product? There are a ton of reasons, including the following:

1. Chinese companies tend not to like or trust foreign countries.

2. Chinese companies tend to be fearful of foreign courts. Who isn’t?

3. Chinese companies and the Chinese government often have a lot to hide. They understand that lawsuits in most Western countries (this is doubly true for the United States) will require they reveal information they do not want to reveal.

4. Foreign courts conduct their business in a foreign language. This makes things difficult on Chinese companies.

5. Foreign courts typically require companies use locally licensed lawyers. Chinese companies tend not to know or trust lawyers outside China.

6. Locally licensed lawyers in countries like the United States or Spain are not cheap and litigation is also not cheap and Chinese companies tend to be reluctant to spend money on services. Chinese companies tend not to be willing to pay — not hourly, not flat fee, not mixed fee, and not even on a contingency fee basis — what it takes to hire competent counsel to pursue international debt collection matters.

7. Lawsuits in most countries are public affairs. Chinese companies tend to prefer operating in secret.

8. It is the rare Chinese company that uses high end international lawyers for their contracts. This means their contracts tend to be very weak outside China and this can turn what should have been a fast and easy and cheap case into a time-consuming and difficult and expensive case.

9. Chinese companies tend to view not getting paid as embarrassing. This is particularly true if the reason the Chinese company did not get paid might involve claims against the Chinese company for acting dishonestly or incompetently.

10. Because it is difficult to collect on debts in China, Chinese companies tend to assume the same is true elsewhere as well.

11. Bankruptcy in China virtually always means creditors get nothing. Chinese companies tend to assume the same is true elsewhere.

12. Companies in China that are going out of business will often take payments from foreign buyers and then provide nothing in return (see above and see China Business Scam Week, Part 2: Bricks for Products). Chinese companies tend to assume the same is true elsewhere. Why pursue a company overseas that no longer exists?

My law firm has many times represented both Chinese companies on litigation matters outside China and companies sued by Chinese companies outside China. Our conclusion from these cases is that Chinese companies generally do not understand international litigation, do not understand the costs of litigation, do not understand what it takes to prevail in litigation, and — most importantly — do not have the “staying power” or financial commitment to pursue litigation or arbitration for the length of time it takes to prevail. We are not the only foreign lawyers who believe these things and I say this because many lawyers sued by Chinese companies know to basically just stall them until they give up.

Then there is the whole State Owned Entity (SOE) “thing.” When a Chinese state-owned company has turnover in its senior management (which is common for SOEs doing badly due to not getting paid), the successor management often does not want to bother going after unpaid debts for fear they themselves will be tarnished with that debt. I can tell you story after story about Chinese company’s falling asleep on their debt collection, but here are just a few:

1. Many years ago, a large China SOE reached out to my law firm about collecting on a $15 million unpaid debt owed them by a U.S. buyer. The Chinese company told us it had a written contract and the American company admitted it owed the debt. Our international litigators were salivating about taking on the case and asked the Chinese company for all relevant documents. Turned out to be a terrible case because the debt had been owed for eleven years (yes, 11 years) and this was the first time the Chinese company had made any effort to collect on it. The statutes of limitations had all run and the Chinese company had no case.

2. Many years ago a large Chinese SOE reached out to my law firm regarding a large debt owed it by an American company. To make a long story short, it eventually came out that the American company had sent an executive of the Chinese company about 10% of the total owed and the executive had in return signed an agreement on behalf of the Chinese company absolving the American company of the debt. When we told the Chinese company of how these complications would increase its attorneys fees and make collection less likely, it walked away from the case.

3. Many years ago, our law firm represented an American company threatened with a lawsuit by a large PRC company.  We told the opposing lawyer our client had never contracted with the large PRC company and all the money our client had paid relating to the widgets at issue had gone to a Hong Kong company. We argued that because our client had never contracted with or paid the PRC company anything, the PRC company had no standing to sue for breach of contract. We also pointed out that if the Hong Kong company were to sue our client, there would be very public records of how the PRC company had been illegally funneling money to Hong Kong for years so as to avoid PRC taxes. The PRC company walked away and we have used this defense with nothing but success ever since.

During the 2008 recession, in Ranking Creditors: China is Dead Last, I wrote how our when our clients prioritize their creditors for payment they put the Chinese ones last in line:

I asked the client why 90% of his payables were Asian and Russian when I had always thought only about half its business was with Asia/Russia, with the other half being with North America. He responded by saying I was right about his business, but the Asian/Russian companies just “didn’t bug us as much to get paid.” We then started examining the payables and ranking them in terms of contract quality. In other words, of these approximately 40 creditors, how did they rank in terms of the strength of their contracts?

By this ranking, all of the bottom seven were Chinese companies.

We then talked about how many of these companies had made any real effort to collect. A bunch of the Korean and Russian companies had retained lawyers who had written demand letters. The letters for the Korean companies (all in English) came from Korean lawyers in Korea and Korean lawyers in Los Angeles, none of which we believed would be able to sue my client quickly. The letters for the Russian companies (all in English) came from lawyers in Moscow. We decided our lawyers would contact the Korean and Russian lawyers to work out payment deals, which we subsequently did. The few Japanese companies to which our client owed money were deemed by the client too important not to pay and so we agreed our client would contact them himself, explain the situation, and start paying.

Not a single Chinese company had yet retained a lawyer and we explained to our client my firm’s history in trying to represent Chinese companies owed money in the United States. We told him of how Chinese companies expected our firm to take on these sorts of cases on a 5% contingency fee basis, with our firm paying all costs, and, believe it or not, sometimes even requesting we guarantee full payment. We told of how we had successfully handled a number of business collection cases for Korean, Russian, and Japanese clients, but had not once even taken one on for a Chinese company.

Way back in 2008, I got the following email from a savvy Chinese national who was attending a U.S. law school. This law student had written this email to a Chinese lawyer in China who had contacted him regarding their working together to collect debts on behalf of Chinese companies and he wanted me to see what he had sent, the translation of which is the below:

What does the contingency fee option look like? The biggest issue is of course the percentage the attorney can deduct (both attorneys fees and costs, i.e. court costs, travel, etc.). The typical arrangement is 30–35% of any recovery after deducting fees and costs for the attorneys, and the rest for the plaintiff(s) if there is no appeal. In appeal situations, the attorney gets 40%, in addition to costs. These figures might sound alarmingly high, but they are the norm in the United States, and frankly, lawyers just put these figures in a contract as a matter of course, and there is hardly any bargaining.

With the above said, Chinese companies must adapt to the rules of the game in the U.S. in order to get competent counsel to collect their debt. My understanding is that most Chinese companies don’t want to advance court costs, and they want attorneys to retain 5%-10% of any recovery. Based on my knowledge and experience, U.S. lawyers/firms will not take on very risky representations with such a low percentage. 5% -10%. These sorts of cases are just not worthy of their time and efforts, and they might end up losing money after paying their overhead.

I am sending you this note not to educate or offend you — not at all. Rather, I think that in order for the vast number of Chinese companies to have a chance of getting their money back and to fight back when wronged, they must know the rules of the game and play by them over here. And they must not insist that the rules here be the same as in China; otherwise, they lose money rightfully belonging to them, and a chance to get it back through competent representation in the courts. Since you are, apparently, leading the efforts in debt collection, I think it is important that you start informing Chinese companies what is reasonably expected over here by U.S. attorneys in terms of percentages, so that they don’t overlook collection of their money entirely simply because U.S. lawyers demand more in their contingent fee agreements.

The lawyer in China walked away.

Since we wrote the above, my law firm has received a number of inquiries from Chinese companies and Chinese lawyers seeking to retain us to oversee their U.S. debt collection efforts or to file a creditor’s claim in a pending bankruptcy or receivership action. Yet, because the Chinese companies are so out of line in their expectation of American or EU attorneys’ fees, we rarely end up with these cases.

Chinese factories are hurting right now and they are desperate and desperate companies do desperate things like agree to ship product without getting any or only very minimal payments upfront. Chinese companies are notoriously bad at paying attention to their buyer’s credit records and I’ve been shocked lately by the incredibly favorable payment terms we are seeing even start-up companies get from some Chinese suppliers. My sense (and I say “sense” because I lack sufficient evidence to back it up) is that for all the complaining by Western companies of getting “ripped off” in China, the dollar value of the rip-offs is actually higher going the other way.

What are you seeing out there?

China manufacturing lawyers
China manufacturing risks are sky high right now.

For the last couple months, a team of our lawyers (a/k/a the PPE team) have been working nearly nonstop on helping companies, charities, and even countries navigate the purchasing of Personal Protective Equipment from China. As we have written extensively, this is a risky business.

For some of what we have written on sourcing PPE from China, we encourage you to check out the following:

And for more on what we have to say about the risks of buying PPE, please check out the following news articles as well:

Most recently, in Face masks, ventilators with fake certificates pushed by scammers as demand for Chinese medical supplies booms, AsiaOne interviewed one of our PPE lawyers, Steve Dickinson, on the risks of buying from Chinese suppliers:

While some do sell viable – if overpriced – products, others sell junk. “They’re not concerned about whether the products perform or not … and they can disappear overnight,” Dickinson added.

Dickinson said claims of special ties with manufacturers were common. So were convincing certificates that turned out to be fake, invalid, or issued to a different company.

Offers to quickly ship high-volume orders in return for cash upfront were frequent, too.

Scam sellers typically dissuade buyers from contacting the manufacturer or conducting other forms of due diligence, such as visiting warehouses where products are stored, he said.

Of nine medical goods suppliers with whom significant product inquiries were made for this story, all but one – a face mask producer in the eastern province of Anhui – provided documentation made out to different companies.

They all claimed business ties with manufacturers allowing them to sell their goods to foreign buyers, but only one produced a contract showing the manufacturer had given them permission to do so.

But this post is NOT going to focus on PPE. I merely led off with PPE because that industry has so clearly and unquestionably become rife with blatant rip offs. But here’s the thing; huge swaths of other manufacturing industries in China have become rife with blatant rip offs as well. Having your product made in China — whatever the product — has never been riskier.

Ordering and paying for something from China and then getting nothing in return or something not at all like what you ordered is happening left and right these days and yet many companies are oblivious to this.These fraudsters are smart and there are good reasons why they spend the money to send you something instead of nothing at all and why they at first claim they will remedy the problems and why they so often continue to make that claim. The reasons are usually two-fold. One, sending even really bad product is less likely to lead to criminal charges than sending no product at all. If the police come by the Chinese fraudster can say, “I sent them the product they ordered. It’s not my fault those Americans/Europeans/Australians are so picky.” Two, by stalling they can keep their scam alive for much longer. They’ve paid for advertising and for a website and they’ve even bought the really bad product (be it spoiled fish, baking powder or bottom of the line window awnings) and they want to maximize these expenditures.

Whenever China manufacturing sees  a big decline in their demand — as is happening right now — YOUR risks of getting nothing or getting junk instead of what you ordered goes way up. China’s manufacturing industry is hurting worse than I’ve ever seen it in my twenty or so years of dealing with China. First it got hit with the trade tariffs, which led to foreign companies looking to move their manufacturing elsewhere. Then it got hit with the coronavirus in China, which caused many factories to generate little to no revenue for many months. Then it got hit with the coronavirus outside China, which has caused worldwide demand for Chinese products to plunge and has caused even more foreign companies to want to move their manufacturing out of China. To sum up, times are pretty miserable for most Chinese factories these days and they know this and they are grabbing for what they can as fast as they can.

The below email (modified slightly so as not to reveal anyone) is pretty typical of what our China manufacturing lawyers have been seeing in greater numbers these days (modified to hide any possible identifiers):

My regular Chinese supplier of widgets never re-opened after the coronavirus. So I then placed an order for 50,000 pieces and they are of the wrong material and they are warped and the sections that are supposed to open freely do not operate correctly because of the wrong material. I spent hundreds of thousands on developing this product and and they will not give that back to me even though they told me they were going to rework the products because they knew there was an issue. Now I have all this product that is useless that I cannot sell and I am paying storage it because I expected I would be able to return it.I’m out so much money and yet still trying to get a new product to market but that is proving really difficult because I have been hurt so badly financially. And then last week I learned that they are selling the product we worked on developing together and that product does not have any of the problems with the ones they sent me. Is there anything you can do to help me?

My response to these sort of emails is always to ask to see a copy of their product development contract so I can determine who actually has the right to sell the product and a copy of their manufacturing contract to see whether the foreign company has any recourse for the (deliberately) poorly made product. Most of the time the company has neither, which usually (but not always) makes doing anything at all to help them just too difficult and expensive to warrant undertaking.

Much of the time, the big frauds are committed by a non-existent company or by a company that is in dire financial straits. Let’s face it, thriving Chinese companies don’t need to steal people’s money and they almost never do. So at the very minimum, you should make sure that the company to which you will be sending the money is actually registered as a company in China and licensed to make and sell the products you plan to buy from it.

The following will help you reduce your risks:

1. Be careful when establishing business relationships with a new company. Do as much due diligence as you can. Send people you trust to do a site investigation of the manufacturing site.  Do a site inspection on goods before payment. Make sure the company exists and is legally able to conduct the business for which you will be paying it. Make sure that it is doing at least okay financially. We do this sort of due diligence work all the time for our clients and in the last few months, nearly 40 percent of the time we have recommended they seek out another supplier.

2. Use a contract that actually works for China and that sets forth clearly what you are buying and what happens if your China supplier fails to comply.

3. Know the market price of whatever it is you are seeking to purchase before you purchase it. Do not trust a company that gives you an unreasonably low price quote. That company likely will either steal your IP or never send you what you ordered or both. See China Contracts: Make Them Enforceable Or Don’t Bother and China Contracts that Work.

4. Consider a small trial order to reduce your risk. The problem with this though is that many scammers will provide you with a good trial and then scam you when you order the full amount. But if you combine this with a contract that works for China and proof that the company actually exists and is operating legally, you will be lowering your risks.

All this begs the big question. Has Sourcing Product From China Become TOO Risky? I will be addressing this issue in detail at a June 10 webinar put on by The International Trade Association of Greater Chicago and the Hong Kong Business Association of the Midwest. Go here for more information on that webinar and to register.

Durante las pasadas semanas, Harris Bricken ha estado trabajando sin parar asesorando a clientes que interesados en importar equipo de protección personal (en inglés, PPE) y otros productos relacionados a la lucha contra el coronavirus, en particular de China.

Lamentablemente, justo en el momento que estos productos hacen más falta, se han agudizado los riesgos que siempre han existido a la hora de importar productos chinos. Estos incluyen el recibo de productos defectuosos o que no cumplen con las especificaciones necesarias, así como estafas por parte de personas que falsamente aseguran tener conexiones con fabricantes en China.

En este breve vídeo, nuestro abogado Fred Rocafort explica el proceso de debida diligencia que lleva a cabo nuestro estudio cuando un cliente desea importar PPE o productos relacionados desde China. Para obtener más información sobre la importación de PPE chino, le exhortamos a que vea este seminario web grabado. Para obtener un descuento del 20%, utilice la clave HB20.


For the past few weeks, Harris Bricken has been working nonstop as we advise clients interested in importing personal protective equipment (PPE) and other COVID-19 related products, particularly from China.

Unfortunately, just as these products are most needed, the risks that have always been present when importing Chinese products have become more acute. These include delivery of defective or non-compliant products, as well as scams by people who falsely claim to have connections with manufacturers in China.

In this short video, our attorney Fred Rocafort explains the due diligence process carried out by our firm when a client wishes to import PPE or related products from China. For more on importing PPE from China, please check out this recorded webinar, and enjoy a 20 percent discount when you use the code HB20.

 

How to Buy PPE from China

Last week, Fred Rocafort (one of our international trade lawyers), Dan Pak (a VP of Procurement at a large East Coast hospital chain) and I put on a 90+ minute webinar on navigating PPE purchases from China. Based on the feedback we have received and the fact that a number of webinar companies have asked us to reprise it for them, we think it was a success. And by success, I mean only that those who attended left the webinar (though staying at home) with actionable information.

The company that put on the webinar — a leading legal webinar/seminar company  — told us they had never put on an event where so many questions were asked. The webinar was about 45 minutes of the three of us talking and then another 45 minutes of us answering questions, but even that was not enough. We got so many questions that we promised to answer them here on the blog and we do that below.

We also have gotten a whole host of emails from people who could not make it to the “live” session but would like to listen to a recording of it. The good news is that there is now a recording of this event online and we can get you 20% off the $175 cost if you type in HB20. Just go here for that recording.

But without further ado, here are the additional questions we have received since the webinar concluded. with our brief answers to the same in bold italics.

How should foreign company PPE distributors that need proof of license and certification from their Chinese suppliers to prove their products’ legitimacy navigate these conversations if the supplier refuses to provide this proof until a purchase order is submitted?” The contradiction here is that without proof of licensure to prove legitimacy to our buyers, our buyer will not buy the products. And if we must purchasing up front for an order of $1 million dollars and then if orders are not up to standards, we take the loss. As we mentioned during the webinar, there is no good reason for suppliers to hold these documents back and those that do are likely engaging in fraud or, at minimum, choosing the PPE manufacturer at the last second. 

For distributors in the United States will an MOU suffice when distributing to governments, and hospitals? Or should distributors require a more comprehensive contract to protect themselves. This will depend on the terms of the MOU and the specific jurisdiction. Generally, MOUs are not binding, and some will explicitly clarify their non-binding nature. Certainly a contract will be less risky, not only for this reason, but for many others. 

As you mentioned, the written law and the realities (especially in China) can be very different. How do we vet the information out there? Talk to reliable sources who are experiencing the issues first-hand, including people and companies who are actually buying; established intermediaries who are not trying to pull the wool over your eyes; and, of course, lawyers experienced with PPE. Keep in mind that not all experiences will correspond to your situation. For example, larger companies, especially those with a presence in China as taxpayers/employers, will enjoy certain leverages that other players will not. And government buying is not the same as hospital buying, which is not the same as charity buying, which is not the same as private company buying. 

For new distributors in the US that do not have much bargaining leverage when procuring PPE, what are some of the methods for negotiating price points, or payment delivery for suppliers that are asking for 100% payment upfront? The harsh truth is that most Chinese suppliers will insist on 100% upfront because they can. Keep in mind that finding a reliable supplier —or even one that has a high chance of being reliable—is a tall order and payment terms may in some instances become a secondary concern—again, assuming the supplier itself is reliable. In some instances, buyers may consider placing smaller order first at unfavorable payment terms and once some mutual trust is established, progressive improvement in payment terms can be sought. Also consider ways of increasing your leverage. For example, if applicable, consider offering licensing or similar opportunities or joining up with other buyers for bigger purchases. If you are going to pay 100% upfront, the key is that you have a contract that makes clear that you are entitled to a refund if your products do not ever leave China. For our own clients, we have sought out Chinese suppliers that will sign contracts making clear they must refund any money paid if their products do not clear China customs. 

Have there been indications Chinese authorities (customs or otherwise) are “scrutinizing” products destined to countries not currently considered in “good relations” with China? (US/Canada due to political tensions)?Yes, but due to the very nature of this selective enforcement, it is pretty much impossible to find concrete evidence, but anecdotally this appears to be the case—and it would be FULLY consistent with Chinese authorities’ M.O. Let’s just say, you would be hard pressed to find anyone involved with PPE who does not believe this is happening. We also believe that countries out of favor with the CCP are considerably more likely to get cheated and to receive bad product.

Can a supplier with an EN149 – FFP2 rating supply US medical institutions as part of the EUA? Yes, according to Table 1 of EUA.

What are your opinions of a factory asking for proof of funds for an order before confirming delivery dates? With such a sellers’ market at the moment, the last thing factories want to do is waste time on leads that go nowhere, especially when the logistics of getting PPE product out of China are so chaotic. Our PPE lawyers generally view such requests as reasonable due diligence on the factory side and not as red flags.

Can you share a Term Sheet template with questions to answer to submit for contract drafting, Sorry but we cannot. In China Contract Templates for $99 Each and in International Manufacturing Contracts: Why Templates are a No-Go we explain why we have never and will never use or sell a template, nor will we give them away for free, especially since we don’t have any. In A China Manufacturing Term Sheet we explain some of what often goes into China manufacturing term sheets. This might prove somewhat helpful to you, but it also highlights why templates are so dangerous in that most of the things we list in that post are either not relevant to PPE or would drive away most legitimate PPE buyers. What I can also tell you is that what went into the typical PPE term sheet two months ago is different than what is going into those today. In the end, it is just too risky for our law firm to provide templates without our first writing out pages and pages of instructions, waivers and disclaimers. 

What is preventing bad actors from under-labelling its PPE products while marketing and selling them to us as medical? Absolutely nothing and scenarios such as these are precisely why—even in the “best” of circumstances—both due diligence on your suppliers and product inspections are critical. I also suggest you read How to Buy PPE from China Without Getting Ripped Off and New and Improved China PPE Scams.

What about European companies sourcing from China? How do these tactics apply? The same basic principles apply to all transactions with Chinese entities. 

We are hearing that FEMA seized PPE product in Michigan and Delaware. How is FEMA making these decisions and what can we do to prevent PPE seizures? Dot your ‘i’s and cross your ‘t’s. FEMA has legal authority to examine exports to determine if PPE should be “allocated” to the government or returned to the US market—make sure you can document the provenance and destination of your products, i.e. they are not exports. Likewise, the FBI is on the lookout for price-gouging—make sure you can demonstrate your products are not headed for the black market. Same goes for intellectual property rights—if a factory offers “3M” products, do not buy them.

What type of registration do importers/middlemen need?  LLC or specific FDA registration?” In the United States, importers and middlemen must register with the FDA. These sorts of rules can and do differ greatly by country.

What would you recommend we put in contracts with our suppliers? What about with our customers? There is no way we can answer these questions without knowing a lot more and even then it would take us hours. Generally speaking, the good contract anticipates all possible scenarios. But also, generally speaking there are a lot of things that would and should ordinarily go into your Chinese supplier contracts that simply cannot in the PPE context due to time constraints and due to the fact that putting them in there will only cause your Chinese supplier to move on to another buyer. This is why it is so important you work with lawyers experienced with Chinese PPE supplier contracts. I would though urge you to read The Five Keys to A China Contract That Works because even with PPE these five things still hold true. 

Are you able to share the names of Chinese companies that supply good PPE product?  Our due diligence is highlighting differences between suppliers—good, bad and ugly—but we cannot share this information if it has come to us from a client because to do so would be to violate the attorney-client privilege. We do though share with our clients the suppliers that we have found independently of our clients and we also have some clients that allow us to release supplier names under proscribed circumstances. 

Since NIOSH N95 masks are not considered medical masks in China, can I claim them as non-medical masks when going through China customs and then import them under FDA EUA for medical use? China recently announced quality inspections for non-medical masks as well. But in any case, it is not a question so much of what you “claim”.  If China Customs considers a mask to be medical, it will treat it as such, regardless of what the exporter claims. Similarly, US (and other country) Customs will make its own determinations as well, irrespective of what the exporter or China Customs says.

I’m a supplier, what’s the best way to get in touch with American buyers? I tried Government procurement forms and contacted hospitals but had few responses. There are countless buyers that badly want PPE product and we work to match up our clients that want product with those that sell product. But what we often see is a seller asking $7 for a product and a buyer that has product on hand and will only pay $5 for that product. I wonder if your lack of response is due to pricing or some other factor, rather than any lack of desire by these governments and hospitals to secure product. 

Many hospitals have policies  that say they will only pay with purchase orders (Net 10) after inspecting the PPE. However, Chinese suppliers typically require large upfront payments. How do we resolve this?  Does the importer typically have to pay upfront and then the hospital pays it back unless they can negotiate for an escrow or Letter of Credit? We cannot stress this enough: Chinese PPE manufacturers and sellers have the leverage and buyers must play by the Chinese suppliers’ rules. Letters of credit and escrow were very rare even in pre-COVID-19 times and they are pretty much non-existent now. Hospitals and governments that buy direct from China are getting better terms, especially if they commit to long-term contracts. 

What if my PPE product gets seized – either by US customs/strategic stockpile or by the Chinese government? Obviously, you should first do whatever you can to prevent that from happening and on that front, our best advice is to know the current rules before you act, and by current rules, I do not mean what you find in just English with a Google search. I suggest you read Will Your PPE Pass China Customs? If your PPE product is seized in China, our first step is to call the right people at China customs to see why that happened. The same is generally true if your PPE product is seized by the US government; our initial first step is to try to ascertain the facts. 

Can you show the language of China’s Announcement 53? http://www.customs.gov.cn/customs/302249/302266/302267/2961602/index.html. For more on Announcement 53, check out China PPE: Just When You Thought it Might be Safe to Go into the Water and Will Your PPE Pass China Customs?

Could you elaborate on how to deal with force majeure clause in contracts with Chinese manufacturers? We suggest you read Do Not Let Force Majeure be a Major Force In Your China Contract and Coronavirus Legal Issues Around the World, Part 2: Force Majeure in Real Life.

In drafting remedies in PPE contracts do you recommended ICC long term arbitration or specific language due to the customs situation? There is no one answer here. Not even close. Your contract should reflect the particular circumstances, including your home country, the seller’s home country, the product destination country, what you are trying to protect against, what is custom for the particular sort of contract, etc. See China Contracts: Dispute Resolution Clauses, where we discuss this generally. 

Most Chinese factories require an MOQ (minimum order quantity) of like 500K to 1M Surgical Masks or even KN95. Is that bull—t or is actually real and how do you usually handle that? Many Chinese suppliers are requiring these sort of big orders, but there are some workarounds, including buying large quantities over time or pooling your order with others. Our China PPE lawyers work directly with China PPE suppliers to convince them that our client is serious about buying more over time

In Dan’s blog post, he said Chinese companies do not tend to take escrow payments. What can assist in negotiating that payment method? Probably nothing. Even under the “best” circumstances, this is not a practice Chinese companies favor. Under current circumstances, Chinese PPE suppliers are even less likely to agree and why should they when there is a line of buyers waiting to pay top dollar for their product. The key is to conduct due diligence on your Chinese seller and to use your contract to protect you against paying and then getting nothing. 

“There is a list of 10 US HTS codes that fall under “medical.” What’s the value of the notification “non medical” on the boxes ?  Does this impact on whether they are inspected ? And second question on US HTS codes:  If I use 62101050, which is coverall for use in contaminated area (duty 0%), I’m told they need extra checks in China. Is that correct ? Because alternatively they are classified as 6310109010 (other overalls and coveralls) and then the import duty is 16%…” In times like these, with so much scrutiny of medical products, US CBP is not likely to pay much heed to box labels or to claimed HTS codes. We have no information regarding treatment of specific HTS codes in China—but there too we are dubious that codes are an important driver of inspection decisions.

If I buy PPE from a Chinese company, and store them with a logistics service provider in China, am I then allowed to export that PPE to a company inside our group in any part of the world ?  Or would that not be possible because we don’t have the export license ourselves ? Intra-company exports are still exports and they will be subject to the exact same China rules and restrictions as inter-company exports. In the United States, the government is exempting intra-company exports from the Defense Production Act restriction, but there is no indication China is doing anything of the sort.

I have a Chinese friend who can obtain 1,000 masks at a time but he said he cannot ship more than that per day due to restrictions. Would you have any idea whether he can ship multiple shipments to different addresses or do you think he will still have an issue getting more than 1,000 daily sent out?” We have not heard of any such numerical restrictions and 1000 seems like a very low, impractical number for even an “informal” restriction imposed at a particular Customs port.

“Can you send me the “official China list”?http://www.nmpa.gov.cn/WS04/CL2590/. Please treat this only as a starting point, as there are many bad actors out there who claim to be XYZ company on this list when they are not. See New and Improved China PPE Scams.

The following questions were posed of us before the webinar and we answered them in the webinar. We would like to answer them here, but we cannot because that would violate our terms with the webinar provider company. We also answered a ton of other questions posed to us during the webinar. If you want answers to the below questions and to those posed during the webinar you can wait at least 30 days for us to publish them here or you can go here and sign up now for the recording of the webinar and then send any additional questions you might have to the webinar company.

1. How can we ensure that a shipment will not be seized by the federal government en route to its final destination after passing through US customs? If, as FEMA themselves suggest, these are the actions of their “anti-price gouging task force.” How are these determinations being made? How can vendors protect themselves and their buyers?

2. Is there a repository of known fake certificates to check against? Or a register of Chinese certifiers?  Little information seems to be available about them online, even on the Chinese internet.

3. Was wondering if Harris Bricken is doing pro bono or discounted work for non-profits? We are discounting all COVID-19-related work by 25%.

4.  What are China’s requirements for boxes to ship out of customs now? Does the chop have to be on every box ?

5. If a manufacturer delivers defective product or fails to deliver at all, what are the remedies?

6.  Have you heard anything about the US DOJ restricting the use of the middlemen in PPE transactions?

7.  What are the major differences between successful and unsuccessful China PPE deals?

8. What one big tip do you have for us?

how to buy PPE from China Webinar

On March 28, in Buying Face Masks and Other PPE from China: Not For the Faint of Heart, we wrote about the difficulties inherent in buying PPE from China. On April 2, in Buying Face Masks and Other PPE from China Just Got a LOT Tougher, we wrote about how China’s new Order 5 had just severely limited who can export PPE from China and how that would make securing PPE from China that much tougher. On April 10, in How to Buy PPE from China Without Getting Ripped Off, we talked about the increasing risks of dealing with scammers and fakes. On April 14, in China PPE: Just When You Thought it Might be Safe to Go into the Water, we wrote about how China’s new Announcement 53 would even further reduce the PPE allowed to leave China.

If you don’t see the trend, let me make it crystal clear: buying PPE and getting that PPE out of China gets riskier pretty much by the day and today is no exception.

When China’s Announcement 53 came out, a number of people (clients included) told our China PPE lawyers  that they’d heard that announcement had been revoked or stricken. We could find no evidence of that and we chalked this rumor up to PPE sellers who did not want their buyers and potential buyers to be scared off. The Chinese government officials were mostly telling us that they were unaware of anything countermanding the Announcement.

For us China lawyers, all this meant we would need to do what we’ve always done with China when a new law, regulation, order or announcement comes out — waiting to see what its impact will be in the real world. We’ve dealt with similar legal issues at least 100 times when it comes to China and our usual advise to our clients is that they wait a few weeks to see what happens and then they either move forward with their deal or not, all depending on what actually happened. That is logical and actionable advice to clients buying your ordinary widgets, but that is not terribly helpful advice for clients that need life-saving Protective Personal Equipment NOW.

What we are doing for these PPE clients is giving them the updated information as quickly as we can get it and the below is what we know so far. I will though do something we have virtually never done on here previously: throw out all sorts of caveats. First caveat. The picture we are getting is super recent and may or may not be representative of what is actually happening. We are getting this information from people we know and trust and so we believe what they are telling us, but they too are seeing only a small part of the big picture and they might just be wrong. But at this point — and with time being of the essence — even preliminary information is better than no information at all. The below is what we are hearing.

China customs is cracking down like never before on PPE leaving China. This means they have plenty of people checking to make sure that the manufacturing company is licensed to make the PPE product to be shipped and that the company exporting the PPE product is authorized to export that PPE product that the PPE product to be shipped has been correctly described in all of the customs paperwork and that the PPE product is of good quality and even that the PPE product can be exported to the particular country to which it is going and can be imported into that particular country.

If your PPE does not qualify under all of the above — no matter when you bought it — it will get blocked from leaving China.

This means if you want your future PPE orders to get through China customs you need to be certain of the following:

  1. The company that is manufacturing the PPE product you will be buying from China is licensed to make that product.
  2. The company that is exporting your PPE product from China is authorized to export that product from China. Note: Many PPE items that did not have this requirement a week ago have that requirement now
  3. Your paperwork is perfect.
  4. Your PPE product is of good quality and not counterfeit.
  5. The country to which the PPE product can legally be sent that particular PPE product from China and can legally receive it.

In the end though, no PPE shipment from China can be considered “safe” until it has cleared customs and been loaded on to the airplane or ship that will take it to the country you want it to go.  But even after clearing customs, there is always a slight risk of a seizure. It is unlikely PPE product would be removed from a vessel that has not sailed or an aircraft that has not taken flight, but with all that is going on in the world surrounding the coronavirus and PPE, even that could happen in China.

So the best PPE contract you can have would provide for no payment until the PPE product you are trying to buy has cleared China customs and been loaded onto the carrier and that carrier has departed Chinese waters or airspace. In other words, no payment until the PPE product has “crossed the rail” in FOB terms. For air freight, this means no payment until  the product has cleared customs and an air waybill has been issued.

The problem though is that virtually no Chinese PPE factories will accept these terms. A Letter of Credit can be set up to guarantee the factory will get paid, but virtually no Chinese PPE factories will accept these terms. An escrow arrangement can be devised, but no Chinese PPE factory will agree to that.

The typical Chinese PPE factory will seek to load all of the risk of its own government’s actions onto the foreign buyer and they can get away with this these days because of the global shortage of PPE products. So usually the best we can do for our clients is a contract provision stating that if the shipment is held up by Chinese customs, our client gets all or nearly all of its payment back. If this is going to be your only remedy, you had better be sure you are dealing with a legitimate and reputable Chinese supplier. This is why we recommend to all our clients that they have our lawyers conduct due diligence on their Chinese PPE supplier.

This due diligence investigation typically consists of our reviewing various Chinese government databases to confirm that the Chinese company from which the PPE products will be bought actually exists and is licensed to sell what it is proposing to sell. These investigations also seek to determine whether the Chinese company is well capitalized, is in good standing with the Chinese government regarding fines and taxes, and not involved in lawsuits that would make one doubt its reliability. We also look at the company’s ownership because that sometimes gives us additional good insight about the company. After we search the Chinese government databases, we do an internet search on the company in Chinese and in English to try to get information about its overall reputation.

I am often asked whether these due diligence investigations of PPE suppliers give comfort and the answer is yes. We have done PPE due diligence searches that have revealed the following PPE suppliers

  1. A PPE supplier that has been making medical products since 1972, has 8 factories throughout China and around $15 million in registered capital. This sort of company is a yes.
  2. A PPE supplier that was until three months ago a clothing manufacturer, but pivoted to make masks. It has one factory and about $1 million in registered capital. This sort of company is a probably yes, at least so long as the PPE shortage prevails.
  3. A broker that was formed two months ago. This sort of company is a no unless it will reveal the name of the factory and permit our client-buyer to contract directly with the factory (which now must check out).

Just in case you want to read more about the chaos that is the China PPE market, I suggest the following:

Oh, and not so by the way, two of our PPE lawyers and a hospital chain VP of procurement will on Thursday, April 23, be putting on a Webinar on how to navigate PPE purchases from China. We will be speaking for 45 minutes and then spending an additional 45 minutes answering audience questions. Go here to read more about that webinar and to sign up it as I am sure it will prove helpful to you.

 

 

how to buy PPE from China

On January 19, 2020, a 35-year-old man who had just come from China was diagnosed in suburban Seattle with the coronavirus. Within days of that event our law firm was representing companies seeking to buy large quantities of personal protective equipment (PPE) from China. It quickly became apparent these sourcing projects would require a panoply of China lawyers, paralegals, and business specialists to help clients who needed fast and decisive assistance in buying PPE, mostly from China.

We quickly assembled what we call our “PPE team.” The first thing our team needed to do was to decide exactly the sort of help our PPE-buying clients needed. Most of our PPE buyers are hospitals, hospital chains, and consortiums of hospital buyers, but we also are working with states, countries, charities, and brokers. What all have in common is the desire to get good product at anything approaching reasonable prices.

For most companies, our law firm’s highest and best use on PPE projects involving China is the following (per the template letter we send to those seeking our assistance):

  1. Making sure the Chinese company proposing to sell the medical products is authorized by the Chinese government to export those medical products. This usually takes very little time. If we find the Chinese company is not authorized to export the products you are seeking to buy from it, we usually will go back to you and suggest you ask the company how it proposes to get you the products when it is not on the list of companies authorized to export those products from China. If we find that the Chinese company is authorized to export the medical products you seek, we will usually immediately move on to #2 below. These authorizations are a constantly moving target, and today China yet again further restricted the products that can be legally exported. See China Tightens Customs Checks for Medical Equipment Exports.
  2. Conducting a basic due diligence investigation on your potential sellers and providing you with a report on our findings. This investigation typically consists of our reviewing various Chinese government databases to confirm that the Chinese company from which you are seeking to buy PPE products actually exists and is licensed to sell what it is proposing to sell to you. These investigations also seek to determine whether the Chinese company is well capitalized, is in good standing with the Chinese government regarding fines and taxes, and is not involved in lawsuits that would make us doubt its reliability. We also look at the company’s ownership because that sometimes gives us additional good insight about the company. After we search the Chinese government databases, we do a quick internet search on the company in Chinese and in English to try to get information about its overall reputation. We then provide you with a 3-5 page report on our findings. Our typical turnaround time on these is 5-8 hours. Not surprisingly, we are finding that the better the company, the greater the likelihood the products will clear customs in China and in the importing country.
  3. Conducting searches to determine whether the products you will be buying can be imported into the particular country in which you will be importing them. We also provide high-level customs advice for products imported into the United States and the EU, and, in tandem with associated lawyers, we can usually provide this advice for other countries as well.
  4. Drafting purchase and sale agreements between you and your Chinese sellers. This includes our providing you with legal counsel regarding terms and payment issues, such things as letters of credit.
  5. Assisting you in securing capable QC assistance in China. It helps to have someone in the factory watching how your PPE is made and making sure that what is shipped is what you bought. There is no substitute for this step, even and especially in times like this.

We also often find ourselves consulting with these buyers regarding countries other than China that are selling smaller quantities of (but often better quality) PPE.

Though we have written extensively about sourcing PPE, we get many emails every day asking that we write more on this. The problem is that whatever we write today will almost certainly be outdated a week from now, but here goes. Before reading the below — which consists mostly of updates — I urge you to read our previous posts, all of which we have translated into Spanish because we are doing quite a lot of work with Spanish-speaking buyers as well, which is no surprise because we have long-standing offices in Spain and many of our US-based lawyers and paralegals are fluent in Spanish, as well.

Now for the latest on what is going on out there and what our PPE team is seeing and hearing.

The PPE market is a complete mess. Every day I wake up to at least 25 emails from someone claiming to have PPE (almost always masks), who I am 99.9% certain does not have anything more than a desire to do a PPE deal. These are people who say they can get KN95 masks for (let’s say) $4 each or N95 masks for $8 each. Virtually none of these people are connected with legitimate manufacturers of these products; they are brokers who think they might be able to score some masks if they are paid in advance to do so or crooks who intend to just take the money and run.

How can I be so sure? Because the companies making the real thing would do not need to reach out to a US law firm to sell their products; they have people lining out their (virtual) door begging to buy their products. I have gotten nearly a thousand of these emails in the past two months, and I have responded to three of them. One was from a US company that had recently pivoted to make face shields. The other was from a US company that just started making face masks. The third was from a close friend with serious connections in Mexico. The rest I ignore. Might there have been a diamond in those other approximately 997? I doubt it. All I know is that it would not have been worth the massive time required to sort them out.

Just to be clear: there are brokers who get real product for real buyers all around the world, and we have clients who have gotten real products from brokers. But I am pretty sure that every instance involving a brokered deal that went through the client knew the broker before the coronavirus began in Wuhan.

Brokers/sourcing agents have always made us nervous, even before the coronavirus. We wrote about this on December 26, 2019, which can be considered pre-coronavirus times. In that post, entitled, Sourcing Agents INCREASE Overseas Manufacturing Risks (Most of the Time) we opined as follows:

About all I can tell you here is that there are a ton of bad sourcing agents and a few great ones, and choosing a bad one will nearly always be far worse than choosing your overseas manufacturer yourself. So if you do decide you need a sourcing agent, choose a good one. A really good one.

It then quotes extensively from a Quality Inspection Blog article entitled Sourcing from China 101, Part 1: Do You Need a Sourcing Agent? that quotes me saying the following about sourcing agents:

I often describe China sourcing agents with the following:  Ninety percent are crooks or incompetents, and most are both of these things. But ten percent are worth more than their weight in gold.

When it comes to PPE, I’d bump the number up to 98%. How then can you be sure you are dealing with the 2%? You cannot be sure unless you truly know the sourcing agent with which you are dealing. There are ways, though, to be sure you are not dealing with a reputable sourcing agent, and one of the biggest tells is when that agent tries to make you believe they are the manufacturer when they are not. But even sourcing agents you know and trust can increase your risk when buying PPE, especially if you do not know from exactly where your agent is getting the PPE.

I say this for two reasons. One, in the end, the chances of whatever PPE you buy being allowed to leave China and enter the country of its final destination will hinge on the actual manufacturer. Makes sense right? And two, most sourcing agents, whether good or bad, honest or dishonest, do not have much in the way of assets. As I mentioned above, one of the things we do for all our clients buying PPE from China is to conduct due diligence on their sellers. Sometimes the seller has been around since the 1970s and has $10 million in registered capital and a bunch of factories scattered throughout China. Other times, they’ve been around since 2016 and they have $1 million dollars in registered capital and one factory. But even the best and most honest sourcing agent rarely has more than $250,000 in registered capital and a few computers housed in a rented office. If you get bad product and need recourse, you are going to be much better positioned to go after a deep-pocket manufacturer than against a near judgment-proof sourcing agent.

But what can go wrong out there? Well, like everything.

The below email is a slightly revised version of what our PPE lawyers have been telling our clients who are looking to do brokered PPE deals:

The big risk is that we have no proof the broker has any relationship at all with the manufacturer. In a normal deal like this where the broker will never take possession of the goods, we would require confirmation of the relationship between the broker and the manufacturer. This would usually be either a copy of a contract or a written confirmation. Neither will want to reveal the price terms of their arrangement and that’s normal and fine. But it is important to know whether the factory: (1) has actually agreed to produce the quantity you want to order; (2) can and will provide the product according to the time frame required; and (3) will ship the product directly to you even though it is not getting payment directly from you. These sorts of things will reduce the risk of you showing up at the factory to have the factory tell you that they have no clue who you or the broker even are. Or, only slightly better, that they know who you are but your product will not be ready for six months.

In Faulty N95 Masks Hamper Hospitals on Coronavirus Front Line, the Wall Street Journal (Austen Hufford) today explained some of the things that can and have gone wrong for those trying to secure PPE from China:

CoxHealth, a hospital system based in Springfield, Mo., recently bought 100,000 N95 masks from a reseller outside its normal supply chain. After one of those masks failed what’s called a “fit test” to assure it is operating effectively, the reseller offered to buy them all back—and sell them to another hospital, said CoxHealth’s president, Steve Edwards. He decided to keep them.

“These aren’t perfect but they have some protection,” Mr. Edwards said. “Everything about it looks legit. But the product itself is clearly not.”

Mr. Edwards said CoxHealth paid around $4 each for the faulty masks, at the low end of a range up to almost $7 a mask that contracting-data provider GovSpend said it has found for N95 masks. That compares with about $1 each for N95 masks before the pandemic, GovSpend said.

Some hospitals in the U.S. are turning to a cast of smaller producers and shadowy middlemen. “We are getting a lot of ‘guy who knows a guy’ stories,” Mr. Edwards said. “We go down every rabbit hole.”

It then quotes me on some of what our coronavirus law team has been seeing out there:

Dan Harris, a lawyer in Seattle who is helping hospitals verify mask sellers in China, said he has reviewed the same “proof of verification” certificate more than a dozen times, indicating it is fake or copied.

“They are either hucksters or con artists,” Mr. Harris said. “Normal safeguards are being ignored right now.”

It then discusses many instances where hospitals and states bought what turned out to be defective masks, and it cites to a company that tests incoming masks and is “finding a crazy amount of bad masks in the market.”

I was also quoted today on PPE in a Los Angeles Times article by Anna M. Phillips, Del Quentin Wilber, and Jie Jenny Zou out today, for an article entitled, States Do Battle for Coronavirus Protective Gear in a Market Driven by Chaos and Fear. I love how this article begins:

The text messages and emails come in the middle of the night from strangers claiming to be middlemen and manufacturers. Deals are cut quickly; millions of dollars are wired overseas. Sometimes the supplies arrive; other times, the too-good-to-be-true offers prove to be just that.

It then discusses how the PPE market mystifies would-be buyers:

In interviews, state and local officials around the country depicted a market that even the most seasoned say has astonished them by its logistical challenges, lack of transparency, and potential for fraud.

Prices of surgical gowns, gloves and N95 masks have skyrocketed. The masks, which used to sell for between 50 cents and a dollar apiece, are now on offer for $5 or $6, officials said.

Government employees have been told that if they don’t pay 50% of the cost upfront, and the rest before the shipment has even arrived, they will lose deals to other bidders. Fearful of having orders seized by the federal government, desperate city and state officials have called members of Congress and other elected officials to ask them to sweet-talk U.S. customs officials.

The experience has been an emotional roller coaster for state and city officials. Working on the scantest of information and often with brand-new suppliers, they have had to disregard longstanding rules in order to act quickly. Too much hemming and hawing, and they could wind up with nothing to show for their efforts.

But without careful investigation, they might buy defective equipment, endangering hospital workers, police officers and paramedics.

“It has been crazy,” Illinois Assistant Comptroller Ellen Andres said.

The article then points out the issues with “middlemen and brokers who hold themselves out as specialists in connecting American buyers to foreign manufacturers” and how “some are legitimate actors working around the clock to track down supplies” and others “are opportunists cashing in on a global pandemic” and it is difficult to tell them apart. It then notes how “some states and cities have refused to work with sellers they don’t know or those who demand payment upfront,” while others “don’t have that luxury.” Buyers often have to sift through “several middle people who then have another relationship with someone who has a relationship with someone in China, who then has a relationship with an actual manufacturer,” to determine “the actual person producing this.” Some “governments and hospitals have hired lawyers and consultants to help them vet suppliers”:

Hartford HealthCare, a network of seven hospitals in Connecticut, is working with Dan Harris, an attorney who specializes in doing business with China, to help verify potential brokers. Since the pandemic unfolded, Harris said his inbox has been flooded with dubious would-be brokers and middlemen looking to offload supplies.

Harris said he suspects that the rising cost of medical supplies is mostly a result of price gouging and profiteering, not an increased cost of doing business. Prices are expected to continue to increase following new export protocols enacted by the Chinese government this month, which will likely limit the number of companies cleared to send medical goods to the U.S.

“Every hospital is dealing with this on their own, there’s really no coordinated effort to weed out these bad actors,” said Dan C. Pak, the network’s vice president overseeing procurement, who has been calling Chinese factories to vet his orders with middlemen. “We are literally at the mercy of these brokers.”

I found myself disagreeing with the following quote in this article:  “’The market is completely opaque,’” said task force member Alex Dixon, who leads West Coast operations for PureStar, a major linen supplier to Vegas hotels.” The market is not completely opaque if you have dealt with China suppliers for decades and you can read the Chinese laws, regulations, rules and pronouncements regarding the export of PPE and you have the ability to identify the real Chinese manufacturers with good reputations and 20 years of business operations as opposed to a  broker who decided to move from sourcing golf balls to sourcing PPE three weeks ago.

It is tough out there, no doubt, and there is not sufficient time or money to eliminate all risk when buying PPE, but there is a ton that can be done to greatly reduce that risk.

 

UPDATE: Alice Su, China correspondent for the Los Angeles Times just came out with an article on the massive risks buyers face from defective PPE and coronavirus testing kits, entitled, Faulty masks. Flawed tests. China’s quality control problem in leading global COVID-19 fight. The below from this article succinctly and accurately describes the PPE chaos:

A growing list of foreign complaints about faulty medical gear and testing kits imported from China has upset Beijing’s designs. Within the last few weeks, scientists and health authorities in Spain, the Czech Republic, Slovakia, Turkey and Britain have complained of faulty antigen or antibody coronavirus tests purchased from Chinese companies — in some cases, costing these governments millions of dollars. Georgia has canceled a contract with the Chinese company that sent flawed test kits to Spain, and Malaysia has opted to buy testing kits from South Korea instead of China because of the Chinese tests’ reported low accuracy rate.

Last week, the Netherlands asked to return 600,000 face masks purchased from China that had inadequate filters and fit incorrectly. On Tuesday, Finland tested a shipment of personal protective equipment, or PPE, from China and found the items unsuitable for hospital use. Australian border officials have also reportedly seized 800,000 faulty or counterfeit masks from China.

The problem is worse at home. On March 12, officials at a State Council press briefing announced that authorities had seized more than 80 million counterfeit or faulty masks and 370,000 defective or fake disinfectants and other anti-coronavirus products in the prior month alone.

Beijing has also tightened export standards in recent days, requiring domestic certification as well as foreign licenses for medical products shipped abroad. Previously, exported medical products only had to have the certifications in receiving countries, such as the European Union’s CE certification, which could be easily counterfeited in China.

But the desperation of states, nations, hospitals and individuals competing worldwide, shelling out millions of dollars to get medical gear as people die by the thousands each day, has created a scammer’s paradise.

“It’s a complete mess,” said Dan Harris, a lawyer whose firm, Harris Bricken, has advised companies on sourcing from China for more than 15 years. He called the current situation “unprecedented,” especially as frenzied Chinese suppliers attempt to recoup losses after months of quarantine.

“A year ago, Chinese companies were fine. Now they’re desperate,” said Harris. “A lot of them know they’re going to be bankrupt in a week. A lot are going to be bankrupt already. So they’re selling bad product, fake product” — and the whole world is buying those products, regardless of how they’re made.

Many of those calling Harris’ firm for help are hospital purchasing managers who are under pressure from overwhelmed doctors asking, “Where the hell are the masks?”

Then there are the middlemen, including experienced distributors and longtime sourcing agents who think it’s easy to shift into PPE. And a smattering of “crooks, who go to the hospital and say, ‘I can get you 5 million face masks’ … And they have no clue what they’re doing,” Harris said.

Meanwhile in China, many factories have pivoted into PPE manufacturing under government encouragement, even though they lack capacity and quality control.

“Everybody is jumping on this market and they have zero understanding of quality,” said Renaud Anjoran, a manufacturing supply chain auditor based in Hong Kong. “But these are high-risk items. If they don’t work, people might die.”

It’s common for Chinese suppliers to export a product under one licensed company’s name, but to source their products from second, third or fourth factories, like a chain of Russian nesting dolls, with little to no traceability down the chain of supply.

“In China, nothing is really black and white,” said Anjoran. “You have manufacturers selling you stuff they don’t really manufacture. They’re making it somewhere else, but you don’t know where.”

There are many ways medical product exporters could get away with counterfeited or substandard goods even with the certification requirements, Anjoran said: Certificates can be faked. Certificates can be real, but altered to display another manufacturer’s name.

Certificates can be valid, with goods made at the factory, but the manufacturer may not be checking the quality of its raw materials — especially the filter material in masks, the most important factor in protecting medical workers from the coronavirus. Testing filter material can take up to two weeks and cost more than $2,000.

“You’ve got speed and greed,” said Harris. “It’s perfect for con artists.”

Many of the newly set-up mask factories also operate in unhygienic conditions, with no process to keep the air clean, Anjoran said, based on his own auditing visits.

“But this is not even on the radar of most buyers these days,” he said. “They’re like, ‘But did you see the masks were dirty? No? OK, who cares! It’s going to save lives. Don’t be picky.’”

Two of our PPE lawyers and a hospital chain VP of procurement will on Thursday, April 23, be putting on a Webinar on how to navigate PPE purchases from China. We will be speaking for 45 minutes and then spending an additional 45 minutes answering audience questions. Go here to read more about that webinar and to sign up it as I am sure it will prove helpful to you.

Compra de Mascarillas y Demás Equipo de Protección Personal en China

 

Por Adrián Cisneros Aguilar* y Fred Rocafort

En las últimas dos semanas he comenzado a referirme a mí mismo -medio en broma, medio en serio- como un abogado con mascarilla. Lo he hecho porque he estado empleando varias horas al día trabajando con empresas que desean comprar cubrebocas y otro equipo de protección personal (PPE, por sus siglas en inglés) en China, así como con empresas que creen que desean comprar PPE en China.

Nuestros abogados especializados en China, tanto en EE.UU., como en España y México están recibiendo un flujo continuo de llamadas y correos electrónicos referentes a protectores faciales, guantes, goggles, lentes de protección, batas, gorras desechables, cubrebocas, respiradores y cobertores desechables para zapatos. Estamos también trabajando con empresas que buscan que les suministren ventiladores. Al mismo tiempo, estamos siendo contactados regularmente por teléfono, correo-e y, especialmente, vía WeChat, por individuos y empresas en China que buscan vender PPE a los Estados Unidos

Existen, fundamentalmente, dos clases de compradores:

  1. El individuo o empresa que “conoce a alguien en China que tiene una cantidad enorme de PPE que quiere vender”, y que desea la ganancia rápida derivada de comprar dicho equipo y revenderlo.
  2. Prestadores de servicios médicos (sobre todo, grupos de hospitales) que desean, desesperadamente, adquirir PPR para proteger a su personal médico.

Los anteriores son dos tipos muy diferentes de compradores. A continuación, trataré de ellos de manera general:

Los Compradores con Afán de Lucro.

Este comprador normalmente llama o escribe por correo buscando ayuda legal para una pregunta y, frecuentemente, una que ni siquiera es relevante. El comprador enfatiza que “necesitan” comprar “rápidamente” una cantidad enorme de PPE en China, por lo que “necesitan” que nos reportemos con ellos a la brevedad porque la negociación concluirá pronto. Frecuentemente, continúan preguntándonos cómo pueden determinar si su proveedor chino de cubrebocas está aprobado por la FDA (Food and Drug Administration, por sus siglas en inglés, la dependencia del Gobierno Estadounidense encargada de la regulación de alimentos (tanto para personas como para animales), medicamentos (humanos y veterinarios), cosméticos, aparatos médicos (humanos y animales), productos biológicos y derivados sanguíneos) o si nuestro despacho puede abrir una cuenta bancaria para que ahí se deposite en garantía el pago, para liberarse una vez que se vea que el producto es conforme.

Nuestra respuesta a estas preguntas consiste en decirles que la aprobación de la FDA normalmente no se requiere para cubrebocas y que más bien deberían preguntarle a su proveedor chino si estaría siquiera dispuesto a celebrar un Contrato de Depósito en Garantía, pues nosotros no sabemos de ningún fabricante que lo haya hecho. Por lo general, comenzamos nuestros correos de respuesta a este tipo de compradores con algo como lo siguiente:

Entiendo que hoy ha llamado a nuestras oficinas buscando ayuda legal para comprar e importar cubrebocas de China, y me atrevo a suponer que lo quiere hacer tan pronto como sea posible. ¿Ha leído nuestro muy reciente post  en el China Law Blog, acerca de las dificultades actuales para comprar producto en China, especialmente PPE? Si no lo ha hecho, lo conmino a hacerlo.

En estos momentos, estamos representando a muchas empresas que buscan comprar cubrebocas en China inmediatamente. Hasta ahora, hemos completado una transacción grande de suministro de insumos médicos y estamos en varias etapas de colaboración con grupos grandes de hospitales, en transacciones que involucran compras por cientos de millones de dólares. Tristemente, muy pocos de los proveedores potenciales de PPE que investigamos pasan la prueba y por tanto, al final del día, pocas transacciones son cerradas. Concebimos nuestra labor como abogados como una de protección a nuestros clientes del montonal de actores malos e incompetentes ahí afuera en estos momentos. ¿Desea que le prestemos esa clase de asistencia?

Cuando nos contratan para estos casos, lo primero que hacemos, normalmente, es investigar al o los vendedores, a fin de determinar si son reales o no. Inclusive, hemos formado, dentro de nuestro despacho un equipo especial de abogados y auxiliares jurídicos (todos ellos con dominio bilingüe del mandarín e inglés) para investigar las fábricas en China y cualquier intermediario.

Nos estamos encontrando con que, muchas veces, la empresa que dice ser la fábrica china elaborando el PPE en ese país no es más que un intermediario buscando asegurar producto si y cuando reciba una orden de compra, o bien, es solo un estafador planeando quedarse con el dinero de la compra sin importar nada (ver abajo).

Hace algún tiempo, la FDA flexibilizó las restricciones impuestas a cierto PPE. Sin embargo, para importar ciertas clases de cubrebocas, tanto los cubrebocas y mascarillas, como la empresa china que los fabrica, deben cumplir con los requerimientos NIOSH (National Institute for Occupational Safety and Health, por sus siglas en inglés, la agencia federal estadounidense encargada de hacer investigaciones y recomendaciones para la prevención de enfermedades y lesiones relacionadas con el trabajo). Hasta ahora, alrededor de 9 de cada 10 certificaciones NIOSH que hemos visto habían sido falsificadas.

Uno de los problemas que seguimos viendo es que empresas chinas que fabrican calcetas o juguetes ahora se promueven en el mercado, aparentemente vendiendo cubrebocas y mascarillas. Esto puede y ha sido problemático en varios aspectos. China tiene sus propios requisitos de fabricación generales y sus requisitos particulares para los PPE. Por un lado, China no quiere hampones afuera vendiendo malos productos, empañando con ello la reputación de su país, como ha estado ocurriendo en Europa recientemente.

Por el otro, China preferiría ver su PPE de calidad yendo a países que son de su agrado, y no a países que no lo son. Como ha ocurrido con su Iniciativa de la Franja y la Ruta, China ha estado utilizando el suministro de PPE como una herramienta geopolítica, y no veo que esta estrategia concluya pronto, si es que alguna vez lo hace.

En nuestra experiencia, incluso las mejores de estas empresas chinas no son completamente conscientes de cuánto su Gobierno NO desea que le estén vendiendo insumos a los EE.UU. o Canadá, en contraposición a vendérselos a países como Italia o España, a los cuales China desea desesperadamente influenciar. Y hablando de España (donde de hecho tenemos una oficina realizando algo del trabajo de apoyar empresas que desean comprar PPE en China), ese país acaba de gastar una pequeña fortuna comprando kits de prueba de coronavirus que simplemente no funcionan. Vean este artículo para algo de contexto al respecto (en inglés).

Luego tenemos la cuestión de qué se admitirá importar en los EE.UU. o la Unión Europea y lo que puede usted vender legítimamente en esos lugares. Dada la actual mezcla de pseudo-fábricas chinas (las que resultan ser simples intermediarios o estafadores) y fábricas chinas reales que no tienen ni idea de cómo elaborar el producto ordenado (por ser fábricas de calcetas) y otras fábricas que no saben cómo elaborar productos que satisfagan los estándares estadounidenses, es un verdadero lío ahí afuera.

Para colmo, vender PPE y no entregar mercancía alguna al individuo o empresa que pagó por ella es LA estafa perfecta en estos días, en un mercado donde la demanda supera con mucho a la oferta y probablemente lo hará por el resto del año.

En las últimas dos semanas he hablado con tres empresas que perdieron, cada una, más de un millón de dólares americanos comprando cubrebocas. Dos de estas empresas habían comprado con su proveedor acostumbrado, que no se especializaba en la fabricación de PPE. Estas dos empresas habían hecho negocios con sus proveedores chinos durante al menos cinco años y por tanto ordenaron -y pagaron- más de un millón de dólares en cubrebocas. Una no recibió literalmente nada, mientras que la otra recibió máscaras de Halloween empolvadas y húmedas. La empresa que recibió las máscaras de Halloween no contaba con un contrato apropiado para China, estipulando claramente lo que estaba comprando. Véase Especificidad en los Contratos Para China y el Azul Universidad de Carolina del Norte, así como Las Cinco Claves Para Tener un Contrato para China que Funcione (ambos en idioma inglés).

Los insto a que lean esto y tomen nota del hecho de que prácticamente a cualquier empresa manufacturera china le está yendo mal en estos momentos, por lo que vender una cantidad enorme de mascarillas o cubrebocas (que ni hacen, ni tienen) se ha vuelto el perfecto canto de las sirenas. Para un buen artículo acerca de qué tan mal le está yendo a la economía manufacturera de China, revisen La Segunda Ola de Contaqios Ya Le Está Pegando a las Fábricas Chinas (en idioma inglés).

Por casi dos décadas, nuestro equipo especializado en manufacturas en China ha venido lidiando con fábricas chinas, así que hemos pasado por varias de las ralentizaciones económicas de ese país. Sabemos lo que ocurre durante estas depresiones, y ést6a es diferente solo en su profundidad y amplitud. Los insto a leer este artículo que escribí, en inglés, para eI Wall Street Journal, durante una ralentización anterior de la economía china.

Como dijo aquí uno de nuestros abogados especializados en China en relación con la compra de insumos médicos en China: “hoy más que nunca, nos encontramos diciéndole a las empresas que si no están dispuestas a invertir tiempo y dinero en hacer todo lo posible para asegurarse que sus compras de producto concluyan con ellos recibiendo efectivamente esos productos, entonces no deberían realizar la compra, para empezar.”

La verificación de la legal existencia de su vendedor es un primer paso necesario, pero hay muchas otras cuestiones a considerar. Para proteger a las empresas que compran insumos médicos de China, nuestros abogados especializados en fabricación internacional usualmente tratan con los clientes las siguientes cuestiones:

    1. ¿Es legal para la empresa extranjera venderle el producto? ¿Obtendrá dicha empresa aprobación de su Gobierno para hacerlo?De nuevo, China quiere que sus Productos PPE (artículos como cubrebocas, respiradores N95 y ventiladores) vayan a países que percibe como “amistosos” y no a países que no percibe como tales, como los Estados Unidos.
    2. La empresa con la cual pretende comprar este producto, ¿en verdad existe? ¿Está legalmente constituida y cuenta con los permisos necesarios para fabricar el producto que planea comprarle? En otras palabras, ¿la empresa es legítima? ¿Cómo puede estar tan seguro de que recibirá el producto que ordene y pague? En Investigación de Empresas Chinas: La Introducción (en idioma inglés), hablamos acerca de este tipo de investigación básica que realizan nuestros abogados para determinar si una empresa china es real o no, y realizamos el mismo tipo de investigación para hacer esta determinación con empresas en cualquier otro país. En un porcentaje muy por arriba del 90% de los casos que ven nuestros abogados, en los que alguien envió dinero y recibió a cambio producto inútil o ningún producto en absoluto, la debacle podría haberse prevenido con una investigación básica de la empresa en falta, la cual habría revelado que la empresa misma vendiendo el producto en cuestión era falsa.
  • ¿Puede importar el producto legalmente?¿Cumple con los estándares de su propio país? Justo esta semana, una empresa nos llamó, tras haber comprado productos que no cumplían con los estándares de su propio país y que por tanto esencialmente no servían para nada. Habían recibido de la empresa china, vía correo-e, vagas confirmaciones de que el producto cumplía con “estándares internacionales”, pero, dado que nada en su contrato estipulaba claramente que el producto debía cumplir con los estándares del país que importaba, el comprador, de irse a juicio, tenía argumentos legales muy débiles contra su proveedor.
  1. ¿Cómo puede estar tan seguro de que su proveedor le enviará el producto en la calidad que le ordene y pague?Inspecciones de control de calidad y contratos relevantes al caso y bien redactados  son aquí claves. Véase LAS Reglas Cuando Se Fabrica en el Extranjero (en idioma inglés).
  2. ¿Cómo puede evitar que su proveedor copies u producto y lo venda por todo el mundo? Véase Cómo Evitar los Problemas con Fábricas Chinas y de Robo de Marcas, Que Están Ocurriendo Como Nunca Antes (en idioma inglés).

Y si se contestan satisfactoriamente todas las preguntas anteriores, viene la cuestión de la contratación del suministro de producto. Nuestro equipo jurídico especializado en China  ha venido elaborando de 5 a 10 Contratos de Fabricación para China al mes por los últimos 15 años, aproximadamente, y eso significa que sabemos no solo lo que funcionará para proteger a nuestros clientes, sino lo que es razonable para China y lo que las empresas chinas aceptarán y lo que no.

Yo entiendo que muchas empresas esperan poder utilizar una cuenta bancaria para ahí depositar en garantía sus pagos al comprar PPE en China. Eso sería genial si funcionara, pero simplemente no estamos viendo nada de eso con nuestros fabricantes legítimos chinos de PPE. ¿Por qué tendría que aceptar el fabricante un pago vía depósito en garantía, cuando tienen una larga lista de compradores dispuestos a comprar sus artículos a precios mega inflados? Incluso nuestros compradores que son grandes cadenas de hospitales están, cuando mucho, obteniendo términos de compra de 50% de anticipo y el resto contra recepción en destino (una transacción pequeña manejó 25% de anticipo y el resto contra recepción, pero se trataba de un proveedor de mucho tiempo). Para una idea general de cómo son estos Contratos de Suministro/Fabricación, véase Contratos de Fabricación en el Extranjero (Contratos de Fabricación de Equipo Original, de Fabricación y de Fabricación de Diseños Originales), en idioma inglés.

Los Compradores Prestadores de Servicios Médicos.

Esta clase de comprador normalmente nos llama o escribe porque ya no saben qué hacer, se encuentran normalmente en un epicentro del COVID-19 y contemplando una inminente y peligrosa escasez de PPE. Este comprador está soportando una enorme presión de sus propios ejecutivos y personal médico para que “haga algo.”

A este comprador le están diciendo varios miembros de su personal médico y ejecutivos que conocen a alguien “que conoce a alguien en China que puede enviarles una cantidad grande de PPE.” Este comprador es experto en la compra de insumos médicos y sabe que no será así de fácil.

Es para esta clase de comprador que hemos formado en nuestro despacho lo que, en esencia, es un equipo de compra y debida diligencia de PPE. Este equipo se encarga de obtener información clave acerca de cada vendedor de PPE propuesto por los clientes, para emitir una determinación afirmativa o negativa inicial en cuanto a su legitimidad. Si dicha determinación es negativo, la labor del equipo termina ahí. Si es positiva, procedemos a hablar con nuestro cliente acerca de hacer un análisis costo-beneficio, con relación a los pasos a seguir.

Si el cliente está comprando sólo una pequeña cantidad de producto (lo cual es raramente el caso) que con desesperación necesita inmediatamente, podríamos aconsejarle que soliciten a nuestros abogados elaborar un contrato sencillo en idioma mandarín y la compra puede proceder rápidamente. Si la compra es por cantidades considerablemente mayores, podríamos aconsejar que se haga debida diligencia adicional acerca el proveedor chino (de nuevo, tan rápido como sea posible), lo que podría involucrar enviar a uno de los nuestros a la fábrica, o hablar con el banco del proveedor o un funcionario gubernamental de nuestra confianza para saber más del proveedor. Igualmente, el contrato para esta transacción en particular muy probablemente será más elaborado.

Ahora, con todas estas transacciones, debemos mantenernos conscientes del objetivo final. Éstas no son operaciones en las que nuestros clientes y aquéllos bajo su cuidado (su personal médico y sus pacientes) puedan ser tan metódicos y cuidadosos como nos gustaría en circunstancias normales. No, ésta es la clásica situación en la que no podemos permitir que lo perfecto se vuelva el enemigo de lo bueno. A estos clientes les decimos que no hay manera de que podamos eliminar el riesgo completamente y que vemos nuestro trabajo como uno de reducir dichos riesgos al máximo posible, al tiempo que damos debida consideración, en todo momento, al objetivo último: salvar vidas.

Con relación a la protección de su propiedad intelectual e industrial en estos tiempos frenéticos, vale la pena repetir lo que dijimos recientemente en  Cuestiones Jurídicas del Coronavirus Alrededor del Mundo, Parte 5: Obtener Producto en el Extranjero Nunca Había Sido Tan Arriesgado (en idioma inglés):

En estos tiempos frenéticos, tendrán que apoyarse en las autoridades locales incluso menos que en épocas anteriores al COVID-19. Las redadas por violaciones a la propiedad intelectual e industrial se encuentran en un lugar muy deslucido en una larga lista de prioridades en casi todos los Gobiernos del mundo en estos momentos. Los Gobiernos están tratando de reiniciar sus economías y, como hicimos ver en No Desesperen. China No Desaparecerá Pronto (en idioma inglés), “China tiene que levantarse porque el Partido Comunista de China necesita que lo haga para mantenerse en el poder, y mantener las barrigas de la gente llenas y sus mentes ocupadas con trabajo (y un poco de entretenimiento “saludable”) son la base de cualquier manual de comunismo.”

Existen, aún así, ciertas cosas que prácticamente DEBE hacer para apenas estar en posición de pelear su propiedad intelectual e industrial. Por ejemplo, en caso de que no lo hayan hecho, éste es un buen momento para registrar su propiedad intelectual e industrial con la Administración General de Aduanas de la República Popular China, a fin de que ésta vigile que no haya producto falsificado suyo entrando y saliendo de los puertos de entrada de ese país. Véase Las Cuatro Mejores Maneras de Proteger su Propiedad Intelectual e Industrial en China (en idioma inglés).

Éste es un buen momento, también, para asegurarse que sus contratos que sus contratos con fábricas extranjeras estén en orden y para resistir el impulso de concluir negociaciones legales con proveedores potenciales. Lean LAS Reglas A Seguir Cuando se Fabrica en el Exterior (en idioma inglés).

En Consejos Para Comprar Mascarillas en China Sin Que Te Quiten Hasta la Camisa (en idioma inglés), Renaud Anjoran, quien dirige una empresa internacional de abastecimiento (sourcing) y control de calidad de primer orden, pinta un panorama distópico y, no obstante, preciso de las realidades en la compra de mascarillas en China, que aplica a la compra de prácticamente cualquier artículo en China en estos días. Renaud también está observando “mucha gente enviando dinero, recibiendo producto por debajo de los estándares requeridos, o nada en absoluto.” Su artículo procede a enumerar diestramente los puntos finos de la compra de mascarillas en China y la mejor manera de protegerse de los malos actores que intentan vender dichos productos.

Comprar producto en el extranjero siempre ha sido riesgoso, pero el COVID-19 nos pone el riesgo, en una escala del 1 al 10, en 11.

 Estos son momentos increíblemente estresantes y absorbentes, pero nos reconforta ayudar-estar haciendo algo para seguir empujando el carro en algo tan críticamente importante. También somos apasionados de ayudar a las empresas con trabajo relativo al coronavirus que hemos aplicado enormes descuentos a nuestras tarifas en estas transacciones, a fin de tartar de devolver algo a nuestras comunidades y a nuestros países y, muy especialmente, a los médicos que arriesgan sus vidas y trabajan una cantidad de horas insana, en un esfuerzo por salvar vidas y aliviar el sufrimiento. Aunque sabemos bien que, como abogados, lo que estamos hacienda es nada comparado con lo que los profesionales de la salud están haciendo, estamos felices de ayudar, así sea sólo un poco.

Así que sigan llamándonos y escribiéndonos por correo-e con sus transacciones de PPE. Queremos desesperadamente ayudarlos a hacer esto como se debe.  

Adrián Cisneros Aguilar es el fundador y Director General de Chevaya (驰亚), una empresa de servicios de internacionalización para Asia-Pacífico. Adrián es Doctor en Derecho por la Universidad Jiao Tong de Shanghái y Maestro en Derecho Internacional y Chino por la Universidad de Wuhan. Lo más importante es que Adrián es el abogado con el que nuestro bufete de abogados trabaja en asuntos de México y para ayudar a nuestros clientes mexicanos en asuntos de China.

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?