Authored by Dan Harris of Harris & Moure, PLLC, China Law Blog discusses Chinese law & how it impacts business in China.
Our China lawyers have been getting a spat of inquiries in the last few months from foreign (mostly American) companies that have lost knock-down drag out disputes with their Chinese manufacturers. The American companies have been getting their clocks cleaned in these disputes to the point that many are having to shut down their businesses.
My goal with this post is to lay out the basics for surviving (when possible) such disputes. First though a bit of background.
Sinosure. Nearly all Chinese manufacturing companies that provide credit to foreign businesses do so because their invoices are insured by Sinosure. Sinosure (a/k/a The China Export and Credit Insurance Corporation) is a massive China State Owned Entity (SOE) that provides Chinese companies with insurance coverage against political commercial and credit risks. Importantly, Sinosure also provides export financing via an agreement it has with J.P. Morgan. Sinosure also covers China SMEs with export volumes of less than two million dollars a year that are unable to bear the political and commercial risks of international trade.
Foreign companies typically never deal with Sinosure until they have a payment dispute with their Chinese product supplier. When that happens, Sinosure usually steps in and threatens to sue the foreign company that owes the money. Sinosure does this by hiring debt collection lawyers in the debtor’s country to pursue the debts of the Chinese manufacturers it insures. Sinosure is very aggressive in pursuing collection cases against American companies, most of whom have little clue about what they are up against.
The Typical Sinosure Case. I cannot promise the below is truly the typical sinosure case, but it is the typical case our China lawyers are hearing about and, most importantly, it is the typical case that has proven so deadly to foreign companies. The below is a composite, written to scare American and European companies straight.
- U.S. company buys $2 million of widgets from Chinese manufacturer for export to the United States.
- U.S company pays Chinese company $1.4 million upfront for the widgets, with the remaining $700,000 to be paid upon approved delivery.
- The widgets that arrive in the United States are of poor quality.
- The U.S. company refuses to pay the remaining $700,000.
- The American company sells the bad widgets at fire-sale prices, netting 500,000 or $200,000 less than the $700,000 it is already out of pocket to the Chinese company.
- The Chinese manufacturer threatens the U.S. company with a lawsuit and the U.S. company threatens the Chinese company with its own lawsuit or with counter-claims for “the bad product and for the damage caused to our reputation. “
- The U.S. company then does nothing for months, figuring there is no way the Chinese company will have the gall to sue and also figuring that suing the Chinese company would be more trouble than it is worth.
- Then all of a sudden, a U.S. lawyer contacts the U.S. company and says that unless the U.S. company immediately pays the remaining $700,000 owed to its by now former China manufacturer, it will soon be sued in the United States. Nine times out of ten, this lawyer has been retained by Sinosure.
- The U.S. company almost always starts out defiant, telling the lawyer that it will never pay anything because it doesn’t owe anything and if the Chinese company were to sue in the United States, it will counterclaim.
- The U.S. company then usually comes to realize that it can no longer get any credit from any manufacturer in China. This is because Sinosure has put the U.S. company on a list of companies to whom China exports will not be insured. Once a company makes this list, it is almost unheard of for a Chinese company to extend that company any credit.
- The U.S. company’s inability to buy from China on credit is usually very tough on them. Remember that this company is already reeling from having lost money on the bad product it received.
- The U.S. company then calls its former manufacturer to try to work out a “win-win” settlement.
- The U.S. company and the Chinese company work out a deal whereby the US company will 1) pay the Chinese company half of the $700,000 it purportedly owes it and start buying from the Chinese company again. 2) The Chinese company will take less than the $700,000 owed to it because it “wants to do business with the U.S. company again.” 3) In return for the $350,000 payment from the U.S. company, the Chinese company will forgive the full debt and, most importantly, it will let Sinosure know that all has been resolved.
Real Life. Unfortunately, as far as I know the above is never ever ever the way it really goes down. Here is what happens in real life:
- The U.S. company pays the Chinese company the $350,000 believing that its emails are sufficient to prove the deal.
- The Chinese company is delighted to have received the $350,000, especially since this is in addition to the full compensation it already received from Sinosure.
- The Chinese company does not tell Sinosure that it received the $350,000 because if it did so, it would need to send that money to Sinosure. Not to mention that it probably has no authority from Sinosure to do such a deal in the first place.
- The Chinese company is not going to start selling its products to the U.S. company again. Why would it when it cannot get export insurance were it to do so?
- At this point the U.S. company is in a terrible position. It is in the hole $200,000 from paying for the bad widgets and it is now in the hole an additional $350,000 for making another payment for the bad widgets. To top this all off, it has an aggressive American law firm (that without any exceptions on those cases in which my law firm has been brought in) has zero clue about anything China. Zero. Nada. Zilch. Rien. Nichts. 没有.
- Unable to afford to hire U.S. litigators to fight the lawsuit that has just been or will soon be filed against them and to hire China lawyers to sort through and explain to a Chinese SOE what has transpired, the U.S. company tosses in the towel.
How to Do It Right. And here’s the thing. The above can all be easily prevented so long as you do not “settle” with your Chinese manufacturer or with Sinosure without making 100% certain that your doing so will actually resolve ALL claims against you. Do not pay anyone anything without first getting a proper written agreement (in Chinese) that makes clear that you have resolved all of the claims against you by both your manufacturer and Sinosure. This agreement needs to work in both China and the United States and it must be signed by all parties (including your Chinese manufacturers) or you could face very troubling additional lawsuits down the road.
And this is only if you are insistent on settling. Most of the time there are various ways to get Sinosure to give up and for you to start getting credit from Chinese manufacturers again.