Many companies continue to purchase container load quantities of product from small manufacturers located on the southern coast of China. This trade has developed a standard form of payment, often termed 30/70 TT. This means: 30 percent down payment on placement of the order, with the remaining 70% due upon shipment. This means 30% of the price is paid before the product is manufactured and 100% of the price is paid before the product is shipped.

Here are some common results of this system:

  • Product arrives in the United States. Upon inspection, it is determined that a substantial percentage of the product is defective. The buyer demands a refund and the Chinese manufacturer refuses. In the alternative, the manufacturer offers a discount on the next order. If this offer is accepted, the buyer is forced to continue to do business with a manufacturer that makes defective product.
  • The buyer arranges for an inspection during the production process or prior to shipment. The inspection reveals a substantial number of defects. The buyer demands a refund of the deposit and the manufacturer refuses, stating that they have already spent the deposit to manufacture the disputed goods. In the alternative, the manufacturer offers to correct the defects and provide a discount on the existing order. If this offer is accepted, the buyer is forced to continue to do business with a manufacturer that makes defective product.

The foreign (usually U.S.) company buying the product then contacts my law firm about filing a lawsuit against the Chinese manufacturer, rather than accept the unacceptable terms. In virtually every case, however, the buyer ultimately determines that the cost of litigation is not justified by the amount of the potential recovery. The buyer is then forced either to abandon the manufacturer and take its losses or accept the terms proposed and continue to work with a bad manufacturer.

We continue to see this problem on almost a weekly basis. We can now describe the situation with a general rule: If you pay in advance in China and a problem arises with the product, you will likely be unable to succeed in defending/prosecuting your rights through legal action unless you have a sealed contract from the manufacturer that has been written (in Chinese) to protect you. That is, once you have made payment, the money is no longer yours. It belongs to the manufacturer and you are not likely to ever get it back.

Though this general rule may seem obvious, it does not seem to be well understood by many foreign companies outsourcing their manufacturing to China. They come to China to obtain a low price for manufacturing their product, but in analyzing the price that they will pay, they fail to account for the risk that they will make payments that will never be recovered.

I am not suggesting that the 30/70 TT system be abandoned. Frankly, for small, container load manufacturing projects there really is no viable alternative in China. What I am suggesting is that the foreign buyer realistically assess its risks and the prices being offered based on those risks. The buyer should also mitigate its risks as much as possible by doing the following:

  • Do not make the second, 70% payment until after an inspection of the goods. In this way, the buyer’s risk is limited to the 30% down payment.
  • Inspect the product as early possible. Time is a major factor in China business. If you find defects early, it is possible that you will be able to resolve the issue in time to save the shipment. If the issue cannot be resolved, then you at least can probably move on to a different manufacturer early enough to obtain acceptable product in time to meet your business needs.
  • Treat the 30/70 TT method as the price for testing out the Chinese manufacturing system. As soon as possible, move to a different method of payment. Use one that does not require payment of any funds until after an inspection has been made. There are many alternative methods of payment in China. Of course, the use of such a method will require a quantity and timing commitment from the buyer that extends beyond the spot, single container type of purchase that is typical for the 30/70 TT method of payment. If you are not Wal-Mart, you are not going to get Wal-Mart like terms.

Risk cannot be avoided in any international business venture. Due to the long history of business operations in China, the risks can be determined in advance. For success, foreign companies operating in China must account for these risks in their business planning.

What are you seeing out there?


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

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

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

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

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

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

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

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

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

Buyer beware.

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

I have always thought it crazy for a company not to have a quality control inspection done of its China product before shipping. Yes, crazy.

The Quality Inspection Tips blog has a post, entitled, “How much does an inspection in China cost?” that puts the need for a QC inspection into proper focus. The post starts out talking about the two kinds of reactions the author usually gets when he quotes his company’s USD $295 daily fee for China quality inspections:

Some purchasers get to talk about their project for some time, see where we would help them, and finally (nearly as an afterthought) ask for the price. I tell them 295 USD per day of work, and I can nearly hear them thinking “wow these guys are cheap”.

They compare this fee to the costs of professional services in their country, or maybe to the total amount of the order, or to the cost of their best alternative (taking a flight to China). So it sounds really low.

With other buyers, it’s the exact opposite. To them, even our basic “no frills, internet booking” service, at 170 USD per product type, seems like a rip off.

They compare it to the salary of most English-speaking staff in China (5,000 rmb), they divide it by 30 days, and they think we make an insane margin. Forget about the main costs of a company that has set up a network in the main regions (training/supervisory/internal control overhead, travel expenses, client communication, taxes in China, etc.).

The post goes on to discuss the second type and their unwillingness to pay the minimal fee for protection:

I learned that the second category of buyers, unless they absolutely have to, will never accept to pay the market price for quality control inspections. They prefer to pay a cheap “agent” who will not do a professional job (if he does any QC job at all), or to simply roll the dice and let the factory ship out. It is not rational because in the end they are probably worse off — it is psychological.

Because my firm charges thousands of dollars to draft OEM Agreements (in Chinese and in English) the companies for whom we draft these agreements typically think nothing of paying a bit more to ensure their China-manufactured products meet their quality standards. This combination of a good OEM contract and good quality control monitoring means our regular clients virtually never call us for legal assistance relating to quality problems simply because they have so few quality issues or their contract means they are well-positioned to resolve them quickly without having to call in the lawyers. Additionally, the same companies that pay for a good contract and good quality control monitoring tend to be the same companies that conduct due diligence on their potential Chinese suppliers before they enter into any agreement with them and it is these three things in combo that truly reduce the likelihood of quality problems.

So the phone calls we get regarding Chinese product problems almost always come from potential clients, not existing ones. Most of the time, the amount at stake for these companies is so little that my best advise is that they be more careful the next time.  Every few months though we get a call from someone out $500,000 or more and I am usually unremitting in my questions to them.  The following is a typical exchange:

Me:  Do you have a contract with this Chinese factory that you can send me.

Them:  No, because I have a purchase order.

Me: Does the purchase order set forth the quality standards required?

Them: No.  I didn’t think that was necessary.  Everyone knows what is required to have a   good quality _________.

Me:  Apparently not your manufacturer, which is unfortunate. Compounding your problem here is that without a written document setting forth the specifics on quality, your case will be much tougher. Did you have someone inspect the goods before they were shipped (knowing the answer to this is virtually always going to be no)?

Them:  No.

Me:  Why not?

Them:  Because the whole point in going to China is to save money and if I pay out for    inspections I won’t be saving as much.

Me:  (long silence)

Them:  Guess I would have saved more by having paid for the inspection though.

Me:  Yeah. Around $500,000 [or whatever amount they have paid for essentially nothing].

Them:  Well, I will talk this over with my [mythical] partner and let you know what we    decide.

Me:  Thanks.

I have no idea what percent of product comes bad if you do not engage in QC inspections nor do I know what percent of product comes bad if you do, but I have seen enough to become absolutely convinced (as is pretty much every person I know who has worked in or around Chinese manufacturing over the last five years) that QC inspections are pretty much always worth the money.

What do you think?  To QC inspect or not to QC inspect?