How to De-Risk Your Business by Verifying the Compliance of Your Chinese Partner

The enormous China market is not risk-free. One of the reasons businesses fail in this market tends to be the hasty selection of a partner without appropriately investigating the company and verifying the resources it claims to bring to the table.

In our recent webinar, Abby Chen, our Senior Associate of Business Advisory Services, shared some real-life dispute cases between foreign invested entities and their Chinese partners at different stages of investment, as well as a few practical solutions to the common risks foreign entities could encounter while dealing with local business relationships.

Here we have selected some typical questions asked by companies with brief answers. To listen to and download the Know Your Chinese Partners: Case Studies for De-Risking and Managing Your Business webinar, please click here.

Why is a Purchase Order (PO) insufficient for a secured business partner relationship? Doesn't a PO serve as legal documentation?

From a legal perspective, PO does serve as a legal document. However, only a PO is not enough if there is a dispute between you and your business partner.

To be more specific, the PO normally includes the commercial terms, i.e. information such as the price, the quantity, the delivery terms, etc. of the goods or services; but in most cases, it lacks legal terms, e.g. the rights and obligations of each party, - for example, what is the liability in case there is a breach of contract, what are the damages, under what circumstances can the parties choose to terminate the deal, what is the applicable law and dispute resolution, etc.

In certain PO’s, we have seen that even the names of both parties may be incomplete with only the trade names printed. Without those important legal terms, it will be difficult, and even impossible, to find a proper solution when a dispute arises.

What is the purpose of issuing a Communication Letter when a dispute occurs?

The direct purpose of a communication letter is to claim against the counterparty.

Another main purpose is to create a piece of evidence, or at least to summarize the chain of events in a letter in case you need to present the story clearly and in its entirety to the court if the matter goes in for litigation in the future.

The third important function is to refresh the limitation of action. In China, the normal limitation of acting for a dispute is 3 years from the date that the dispute occurs. If a dispute occurred, say, 2 years and 11 months ago, and you have been silent and taking no action during this past period, you must seize the last month to at least send out something formal to express your claim against the counterparty of the dispute, e.g. sending out a communication letter indicating your claims. The 3 years of limitation of action will then be re-calculated from the day when you send out this letter.

If the transaction is one-off only, do we still need to prepare a concrete agreement?

Having a concrete agreement is always necessary no matter whether the transaction is one-off or not. Don’t push your luck, even if it is a one-off transaction, unless you are ready to take the risk.

If you were lucky in the first one-off transaction without a concrete agreement, you might feel you have built up “trust” in this partner. This does not mean you will always be this lucky with other additional “one-off” transactions which may become bigger and bigger - without a concrete agreement, “luck” and “trust” could tun into a disaster.

How to draft a clear and formal agreement? What kind of agreement is considered a good agreement?

Normally, when we draft the agreements for the client, we prepare them in two parts: one part for commercial terms, and the other part for general terms and conditions.

Commercial terms are issues which the contracting parties need to discuss and decide, mainly including the good or services, prices, payment terms, and other terms closely related to economic interests about the goods or service itself.

General terms and conditions are related more to the rights and obligations of each party, like what is the liability of both parties in case of breach of contract, what are the damages, under what circumstances can the agreement be terminated, what is the confidentiality obligation of both parties, if this is a bilingual agreement then which language prevails if there is any discrepancy, what are the applicable laws, and the method for a dispute resolution.

How to conduct a thorough background check on my counterparty to avoid any fraud?

Firstly, you should pay more attention to your Chinese partner’s Chinese company name than the English name since it’s hard to use the English name to locate a Chinese company via the internet in China. A formal company name should include the administrative region, the business name, and the industry description - for example, Dezan Shira & Associates (Shenzhen) Ltd.

After simply checking the name word by word, it is advisable to use a public database to do further research - such as Tianyancha (www.tianyancha.com), Qichacha (https://www.qcc.com), Aiqicha (aiqicha.baidu.com). You can input the Chinese company name and find whether this company actually exists. Moreover, you can obtain basic company information – when the company was founded, its primary business scope, personnel profiles, information of the shareholders, company address and so on. 

Secondly, check if the name of your Chinese partner is same as the one on the company chop, which is registered in the official system and has public credibility. It’s important to check if the company chop used by your Chinese partner is the correct one. If not, please further verify its identity in case someone takes advantage of it.

In addition to the background check, you could find someone you trust, preferably someone aware of the local systems, to follow the entire transaction with you. The purpose is to show your Chinese partner you have backup here, like “Hey, although I am not in China, I do have some Chinese partners/friends who can help me with this.” Moreover, for linguistic and cultural reasons, it will be easier to identify the credibility of your Chinese Partner when the language barrier is removed.