Meet the Expert - Dewit Law Office
Risks analysis and countermeasures of engaging international trade in China
To succeed in capturing opportunities and securing competitive advantage, foreign enterprises must be fully aware of the risks when doing international business in China and prepare to take appropriate measures to mitigate those risks.
In this Q&A, we pointed out the risks of international trade as an example.
Q: What are the most common risks for foreign enterprises in doing international trade in China?
A: Risks in international trade with China can be divided into several types, such as,
- Market risk
Market risk is the risk of loss due to changes in the market. The main market risk faced by international trade enterprises is exchange rate and commodity price risk.
- Commercial risk and default risk
In addition to the market and policy risk, the main risks a foreign company may encounter are commercial risk, we made a list here for a better understanding.
- Buyer’s insolvency/credit risk
It refers to the inability of the buyer to honor full payment for goods or services rendered on due date.
- Buyer’s acceptance risk
It happens when the buyer’s non-acceptance of goods delivered or services rendered, which may create difficulty for the seller to dispose the goods or encounter working capital problem.
- Seller’s performance risk
A seller may fail to carry out his obligations in a sales contract, usually due to seller's inability to provide the required quantity or quality of goods, fraud may also happen in this scenario.
- Transit risk
It also often happens that goods being damaged during shipment. Failure in addressing transit risk may result in heavy replacement cost or performance risk.
- Intellectual property risk
Enterprises may face the risk of intellectual property right infringement in international trade.
Q: What are the possible countermeasures to avoid trade risk?
A: Careful preparation to avoid legal problems in the first place is the best solution. To deal with the potential risk, following practices are helpful:
- Conduct due diligence or business background check on the counter party
Conducting due diligence is perhaps the most important step before entering a formal relationship with foreign partners. Companies must be careful to exam and verify the legal status and financial capacity of foreign partners before signing any business contracts with them.
If your budget allows, conducting the business background check on your potential business partners is also very useful.
The following is a list of resources to consider when performing due diligence on your counter party:
- Check online reviews.
- Review its websites and follow up by telephone.
- Verify its registration, certification, legal address and whether it is now still in the legitimate business activities.
- Check the original and copy of its business license, product certificates and other official or recognized documentation related to your business/products.
- Verify its local registration and check the reputation of local government officials before committing to a particular locale.
- Understand its ownership structure, political connections, and hidden power brokers.
- Visit the party yourself or outsourcing the background check to a professional third party.
- Sign written contracts reviewed by lawyers
It is necessary for enterprises to sign a detailed written contract with their counter party, and ensure that the contract and documentary credit does not contain erroneous or ambiguous terms and conditions.
Most international sales contract provisions are similar, but the devil is in the details, and each of these provisions will have its own ramification if an actual dispute occurs. So it is advisable to consult a lawyer to help negotiate and draft the contract with more favorable provisions. Provisions stipulating commitment and guarantee, quality and inspection of goods, trade terms, liabilities for breach of contracts and application of law and dispute resolution method are especially essential to better company’s interests.
- Choose safer payment method
Enterprises should carefully choose payment method in international trade. Generally, payment methods like letter of credit (L/C) issued by a bank with high credibility and escrow service are safer than credit cards and wire transfers. For more complex international transactions such as construction projects and production line imports, several payment stages will be set up with a combination of several payment tools.
- Other practices
Insurance coverage and international factoring are mature mechanisms of risk shifting for international trade enterprises nowadays.
Q: What are the common problems related to quality of goods and how to prevent them?
A: Quality has been a major concern for western enterprises trading with Chinese partners. On one hand, products importing from China may be compromised on quality. On the other hand, merchandise exported to China may be subject to the risk of being detained or returned due to quality and technical standards issues. There may be the following practical actions that enterprises should consider to protect themselves from quality concerns：
- Set a clear definition of “quality” in the trade contract. Provisions stipulating the exact standard of product quality, delivery terms and inspection agency will set expectations for both parties, and may determine the upshot if a dispute arises.
- Consider placing an initial order for samples, rather than making an initial large purchase. Once the trust between two parties is established, they may proceed with larger purchase orders.
- Identify and use multiple sources of goods so that alternatives are available in the event of unjustified price increase or quality deterioration.
- Produce the goods strictly in accordance with the agreed standards. Examine the goods and keep the inspection report and other necessary papers for further verification. For example, in the production line trade, an installation record should be made and signed by both parties for confirmation during the installation process.
Q: When disputes arise, how can I protect my interest and settle the dispute properly?
A: It is common practice for enterprises doing business with Chinese partners to seek the advice of a lawyer who specializes in PRC law to deal with disputes. Here are some tips to help you obtain an advantage in a dispute.
- Have a contingency plan
Enterprises should always have a contingency plan against unfavorable events. Specific recovery plans are needed to cover different risks, such as non-performance risk or product quality risk.
- Retain and collect evidence
Evidence plays a crucial role in dispute settlement. Documents like contracts, email contact and any evidence related to the dispute shall be well kept for further references.
- Know your options for dispute resolution
Before entering into a contract in China, companies are suggested to take appropriate legal advice on including dispute resolution clauses and governing law clauses in the contract to plan how, where and under what law, any disputes will be resolved. Chinese law restricts both the choice of law and the types of resolution mechanisms that can be used in China-related commercial contracts, so the contract needs to be drafted carefully.
You can take the following methods of solving a dispute depending on specific circumstances of the case.
Simple negotiation with your partner is usually the best method of dispute resolution as it is the least expensive and it can preserve the working relationship of the parties involved.
The principle of mediation is that the parties may present their proposals to the mediator who suggests a solution based on those proposals. In both the arbitration and litigation contexts, mediation represents an early step in the resolution of the dispute.
In China, arbitration offers many advantages over litigation. A major advantage is the efficiency. In addition, the proceedings and rules of arbitration are often more transparent than litigation.
A final way to resolve a commercial dispute in China is through litigation in Chinese courts. Court rulings are subject to appeal, which means litigation may continue for years, along with a long enforcement period.
About Meet the Expert
The BenCham online knowledge sharing programme - Meet the Expert - is aimed at sharing knowledge from BenCham's members on a variety of topics covering from regulation updates to the release of new policies, from the f&b market to cross border e-commerce and from the One Belt One Road Initiatives to the effect of the Brexit on EU SMEs doing business in China.
Every month we will invite one or two of our member experts to answer the questions you have.
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- Ma Fengmei. Legal prevention and control of contract risk in international trade [J]. China Business & Trade, 2011, 07