Practical and Legal Measures
We provide critical and timely information that assists our clients achieve their commercial goals in China . CS Alerts are one of the ways that we deliver such information.
Many of our clients and prospective clients contact us seeking assistance in the context of being defrauded in a trade transaction. In some cases, the fraud takes the form of intentional fraud, such as a trading company that has effectively vanished after receiving a significant up-front cash payment. In other instances, the fraud is, in fact, not fraud but rather a significant breach of an implied warranty or material contractual obligation but the breach is of such a nature that the buyer feels as if they have been deceived.
Below we list guiding principles and practical and legal measures a buyer can adopt to mitigate the risk of fraud in the context of trade.
Guiding Principle – Common Sense
The single most effective tool at a buyer’s disposal is common sense. Assume the transaction was occuring in the buyer’s home country and ask: How would a reasonable buyer behave?
For example, would the buyer make an up-front cash transfer prior to confirming the quality and quantity of the subject products? Would the buyer make additional cash transfers after dubious excuses and questionable scenarios have been put forth by the seller as reasons why the initial cash transfers were insufficient or had been misappropriated?
In short, the buyer should not behave commercially in a manner inconsistent with how it behaves commercially in its own country, even if the seller insists that “this is how we do it in China ” or “this is the Chinese way”.
Guiding Principle – Prevent, Prevent, Prevent
It is much more effective to prevent a fraud or breach of a contractual provision rather than seek a remedy after the fraud or breach has occurred. Therefore, the buyer must commit resources up-front (a) to learn about the seller, (b) to effectively document the agreement and (c) to monitor the transaction.
Specific Steps – Learn About the Seller
Some specific steps the buyer can take to learn about the seller include:
(i)visit the seller’s facilities;
(ii)require several references from the seller;
(iii)require a copy of the seller’s business license and export license (which the buyer will have to translate);
(iv)require a copy of a bill of lading from the seller to another buyer.
We note that item (iii) will allow the buyer to ensure that the seller is in fact duly licensed to manufacture, sell and export the subject products. If the seller is not duly licensed, then the products will originate from a third party, the manufacturer. As we discuss below, if the seller and the manufacturer are not the same party, then a three party contract should be entered into among the manufacturer, seller and buyer to protect the buyer.
Item (iv) will allow the buyer to ensure that the seller has the legal right to export the subject products. One of the privileges of having a right to export the subject products is that the seller will be able to receive foreign currency; note that the foreign currencies are not allowed to freely flow into (or out of) China. If the buyer does not have such legal right, then the buyer will have to use an exporter to export the goods. Again, if the seller and the exporter are not the same party, then a three party contract (or perhaps a four party contract if the manufacturer and seller are not the same party) should be entered into among the seller, exporter and buyer to protect the buyer.
Should the seller hesitate to provide you with any of the above information, you should be extremely wary with proceeding with the transaction.
Specific Steps – Document the Transaction
In the event that the buyer is buying the subject products directly from the seller, the sale agreement will be relatively straightforward. Common sense provisions such as the payment terms, the quality standards and the delivery terms should all be included. In addition, the buyer will want to specify who will have the obligation to clear the subject products through customs.
A critical term to be included is specific damages if any of the material terms are breached. If there is a breach of a material term, the buyer can rely on this term to directly seek damages instead of first having to prove the damages.
In the event that the seller, manufacturer or exporter are not the same party, then the sale agreement will be more complex, setting forth which party is obligated to perform which functions and how the transfer of payments will reflect such division of labor. In the event of a dispute, such clarity will mitigate the risk that the various parties are unclear as to who will bear liability.
It is extremely critical to bear in mind, however, that a sales agreement is merely a piece of paper. The buyer must still rely on common sense, be aware of who the seller, manufacturer and exporter are and closely monitor the transaction.
Specific Steps – Monitor the Transaction
The single most important step in the entire process of purchasing products is to monitor the transaction closely. Specifically, payments in full should not be made until the subject products have been inspected by a trusted third party and, immediately after such inspection, are sealed in a shipping container and immediately enter the control of a trusted shipping agent and are no longer under the control of the seller.
For smaller buyers, this step in particular can present unique challenges given that the scope of the subject transaction may not justify committing the resources necessary for such inspection. Smaller buyers must be creative in finding adequate solutions. For example, small buyers can form a group that purchase products from a given area or province (i.e., Guangdong Province ) and together engage an inspection agent. Such a system will require organization and trust among all the buyers.
Regardless of the challenges, the burden is on the buyer to ensure that the transaction is adequately secure. Failure to do so can lead to a costly and painful odyssey.