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How to Do Due Diligence on Chinese Suppliers?

Often I’m asked about how to do due diligence on Chinese Suppliers and how to be sure it’s safe to do business in China.

Some of the short questions I’m asked are things like:

  • How do I know if it is it safe to do business with this supplier?
  • Are there ways to tell if this seller is legit?
  • Is it a good factory to do business with?

How to Do Due Diligence on Chinese Suppliers

In today’s blog post I want to offer simple, effective and affordable ways to conduct due diligence.

When we talk about verifying the legitimacy of a factory we are really taking a look at 3 distinct levels of security which fall under the general category of Due Diligence.

Scam Assessment:  Is the company real?

If yes, move to level 2:

Corporate Assessment:  Who owns the company? Does the seller have a good reputation? Are they financially stable?

If the research findings are positive, we move to level 3:

Quality Assessment:  Does the supplier have the ability to product the products I want to buy?

Who Conducts Due Diligence and How Much Does It Cost?

While Scams Assessments, Quality Audits and Corporate Research all fall under the general category of due diligence during the supplier verification phase, they each require radically different skill sets to conduct and are generally offered by different service providers. At each level, there are tasks which you can do on your own, so let’s look at both the “Free do-it-yourself (DIY) options” first.

Free/DIY options for Scam Assessments

Have you heard about SupplierBlackList.com?

www.SupplierBlacklist.com is where buyers are helping each other in their due diligence on Chinese suppliers (and other countries) by basically exposing suppliers that did them wrong.

It’s no secret that most of the online supplier directories like Alibaba and Global Sources make their money from the sellers that list on their directories.

I would argue that Global Sources does a much better vetting process than the other major platforms, but at the end of the day, the suppliers are paying to be listed, so there is a built in conflict of interest.

According to the Supplier Blacklist website:

Online supplier directories receive listing fees and sometimes commissions from the suppliers. As a result, there is little incentive to delist poorly performing suppliers even when buyers are abused.

The legitimacy of so-called “verified supplier” directories is highly debatable.  To complicate matters, there is no functional Better Business Bureau or government entity willing to crack down on scams and unethical practices overseas.  SupplierBlacklist.com is a free, user-generated platform designed to fill this void in the marketplace assisting you in performing due diligence on Chinese suppliers.

If you have developed a good supplier, keep that secret to yourself. But if your vendor has done you wrong, tell the world about it!

SupplierBlacklist.com tracks suppliers (factories, brokers, trading companies and other forms of sellers and service providers) around the globe who have under-performed in the following areas:

√  Poor Quality

√  Missed Lead Times

√  Compromised Intellectual Property

√  Lack of Labor & Environmental Compliance

√  Contract Violations

√  Scams & Other Unethical Activities

Since SupplierBlacklist.com is free, it is a good place to start your anti-scam research when performing due diligence on Chinese suppliers.

Affordable options for Scam Assessments

A Red Flag Assessment (RFA) is the ideal tool for clients who are buying from Chinese suppliers.  The RFA will help you source safe, avoid scams and confirm that the terms of the deal are fair. Visit here to see a sample RFA and learn more about the service/fee structure.

Free/DIY Options For Corporate Assessments

There are some free and do-it-yourself options for corporate assessments. Below are 2 of those options:

  • Ask for Refrences
  • Visit the Factory

Ask For References!

Most buyers skip this important step. But it doesn’t cost anything to ask for references and follow up with an email or phone call.  Suppliers are unlikely to hand out their entire customer list, but if they can’t give you one or two happy clients…run away and find a new supplier!

Visit the Factory

This may be the single most important step in finding the right supplier when doing your due diligence on Chinese suppliers.

Sales people in China are very good at telling you what you want to hear.  So visiting the factory can be a real eye opener and while you are there pick up a copy of the business license and verify that the name on the license is the same name as on the purchase contracts and matches the name on the bank account.

If you have a contract with the same company you are paying, it will protect you should something go wrong later.

Get a friend that speaks Chinese and have them plug in the name of the factory into the business registry of their given city in China.  In most parts of China you can find out of the business license is still active and who is the legal owner/representative of the business.

Affordable Options For Corporate Assessments

AsiaBridge Law’s Corporate Assessment (CA) service is the ideal tool for clients who want viability into the stability, assets & reputation of a target company.

This report is particularly of value if you are:

  • Thinking about entering into a business arrangement with a Chinese company to buy or sell goods.
  • Exploring a JV or investment partnership with a Chinese entity.
  • Considering litigation against a Chinese company. If a company doesn’t have assets, it’s not worth the effort to fight and win only to remain uncompensated!

It is recommended to conduct the CA on new business partners and have follow up reports done periodically (at least once per year) to expose any changes in the stability, assets and reputation of the target company. Discounts are available for multiple reports if booked in advance.

Visit here to see a sample CA report and learn more about the service/fee structure.

Free/DIY Options For Assessing the Factory’s Quality Systems

Without visiting the production site in person while doing your due diligence on Chinese suppliers, it’s hard to assess if the seller has the means to product the given product you want to buy. Do not just make it one time, but make it over and over again at the quality level, lead time and pricing point you need.

But if you visit the seller in person and get a look at the manufacturing, here are two video tutorials that will teach you what to look for:

Comprehensive 1 hour 7 part video tutorial on how to spot a good factory and avoid the bad ones.

Affordable Options For Assessing the Factory’s Quality Systems

Most simple factory audits (SFA) cover the following:

  • Quality System: on-site visit to confirm if there is a QC system in place. If yes, what is the auditor’s general impression of the system?
  • Employees and Workforce: An overview of HR policies, management style and workers situation.

Quality Systems Auditing is outside the scope of services at AsiaBridgeLaw.com, but contact our friends at www.SourcingServiceCenter.com and they can make some introductions.  For your reference, most SFA’s can be conducted in 1 day and cost around 500 USD if you hire a professional firm.

If the auditor charges a very low fee it probably means they make their money by receiving kickbacks from the factory. So select your auditing firm very carefully.

Related Blog Posts on Quality Auditing

Managing Expectations about Due Diligence in China

Things change fast in China. If key managers leave or the product line is changed, good suppliers can go bad overnight.

So if you are paying for due diligence, ask how “fresh” it is!

In my opinion, substantial due diligence at all three levels is essential when sourcing from China.

Perhaps I am jaded after living here in China for a long time. Maybe sometimes I assume the worst unless proven otherwise.

Remember, do the following…

  1. Scam Assessment (Level 1):  Is the company real?
  2. Corporate Assessment (Level 2): Who owns the company? Does the seller have a good reputation? Are they financially stable?
  3. Quality Assessment (Level 3): Does the supplier have the ability to product the products I want to buy?

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How To NOT Get Knocked Off When Sourcing From China

Knocked Off When Sourcing From China

Do you want to learn How To NOT Get Knocked Off When Sourcing From China?

If you are asking these kinds of questions, this article is for you!

I got a great idea, but I worry that it will get knocked off by the factory? I’m not sure if I should file the patent first or use an NDA to protect me? Who owns and controls the idea when you jointly develop it with the factory? If I sign an agreement am I locked in to buy from this unproven supplier? What is the time frame to get my contracts and IP protection in order?

Below is the Q&A with a buyer who was stuck in an awkward situation with their supplier. Basically, they started cooperation on a project with a China supplier without agreement in advance on the costs involved to finish the idea and who ones the IP.  Shame on the buyer for not sorting these items out in advanced. But, sadly, it’s a common mistake, so in this blog post we share the Q&A.  We also offer some related resources at the end of the blog post.

(more…)

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Can a Foreigner Register IP in China?

Here is a short Q&A for a very common question about foreigners registering Intellectual Property (IP) in China

With regards to the certificate of incorporation, can the company holding the IP rights in question be registered in the UK? Otherwise, what options do we have?

 

The applicant for the IP in China could be any entity or individual, regardless of physical location. A lot of people don’t realize. You need not be Chinese to register IP in China.
Related Content:

China Sourcing Crash Course

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If the black and white logo is registered. Is my IP protected in color?

Here is a short Q&A for a question that gets asked sometimes regarding IP registration for logos.

At this stage we are interested in registering the attached logo, as we are already pushing through a PCT application that will buy us a couple of years extra time. As the logo is in black and white I presume the trademark protection will cover its use in any colour?

Yes, but it’s better to check the application date of the patent, so you will know for sure when the PCT will expire.

Yes, correct. In China, protection will cover its use in any colour?

Related Content:

https://www.youtube.com/playlist?list=PL7c0lgIfa07XodpGFpPiKa2AO41LmnyFR

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How to structure office hours in your Chinese company

Client writes in to ask about labors laws and how to set up the office hours for his Chinese staff.

As this question gets asked a lot, here are some basic points for your reference:

Just wondering if I could borrow your brains and experience and get some advice on a decision that’s been on my mind for a long time now.

We currently work every alternate Saturday (so a 5.5. day work week) like a lot of other sourcing companies in China. I have been seriously thinking about cutting it down to 5 days instead. What are your thoughts on this? How are you dealing with this now? I feel, in order to attract the best people and to compete with “large companies” (outside of sourcing industry too) it is critical to offer something more than what a lot of Chinese companies offer and this seems to be one of those things, especially in terms of hiring married employees. However, at the same time, as we are in an industry with such tight margins, I wonder if this would be make us less competitive/productive.

 

Excerpts:

If you need your people to be flexible and come in on evening and weekends when clients are in town or heavy workload, then you can’t be too pushy with set work hours or you will end up paying a lot of over time.  If your business is such that people can do their jobs during normal work hours, then a more structured format like the current one you have it sound.

In the other email you mentioned your business is slow at the moment. Know that another option is get out from under all those HR/ Admin headaches to focus on marketing and outsource the project mgmt. to a 3rd party like this one.

As you have AsiaBridge Law on retainer, we would be happy to come over to your office to review your HR policies and make some practical suggestions on how to optimize your office hours while staying compliant with local labor rules.

 

 

Related Content:

Is it Legal & Safe to Hire a Freelancer in China?

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How to motivate a non-responsive supplier?

When is the best time to initiate a legal course of action?

Below is a typical case for reference if you are considering legal action against a Chinese entity.

I am in the middle of collaborating with a Chinese company which is located in Dalian China.  The total order is for about $67,200usd (3×40’hq Containers)  So far I have sent them about $16,800usd (25%) as advance.  As of today, they are far behind on the delivery date, among many other issues I am facing in dealing with this company such as quality issues, false promises, deceits and lies and so on.  I can give you further specific dates, documents & details later.  The delivery date for all 3 containers was on March 15th or before, but as of today only one container has been shipped (which was also delayed shipping).  My reason to contact you is to find out when would be the best time to initiate a legal course of action and your legal assistance?  Should I wait for them to finish all the good and ship it out?  Should I wait until I have received the goods and release documents in New York?  If and or when should I pay the balance payment?  What is the proper course of action?  I would appreciate your response.

 

We see a lot of cases like that and offer some suggestions:

A diplomatic and carefully crafted demand letter and follow up from a Chinese lawyer in Chinese to a Chinese company usually has two outcomes:

 

Possibility 1: the seller realizes you are serious and the dispute is resolved

Possibility 2: the seller stops all communications with you/lawyer and prepares for a court case.

 

Key points:

If the seller knows a court case is coming, they will probably try to use the remaining 2 containers as leverage.  If you can risk a delay in having those ship until the dispute is resolved, then I would suggest you move forward with the demand letter and follow up conducted by our Chinese lawyers on your behalf.

 

I almost forgot, have you heard about www.SupplierBlackList.com?  It’s a free website where buyers like you and I can post bad suppliers and expose them to the world.

 

Related Content:

 

 

About the author: Mike Bellamy

Guest Blogger & Chibridge Advisory Board Member

Based in Asia since 1993

Founder of the PassageMaker family of companies

Business Lecturer at the China Sourcing Academy

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Is it Legal & Safe to Hire a Freelancer in China?

Questions & Answers

Q: More and more websites (like oDesk.com, Elance.com Freelancer.com) in English and Chinese are connecting international business people w Chinese freelancers to project work on a part time and sometimes full time basis. What do the Chinese HR laws say ...

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Work With Your Chinese Attorney to Sue Your Supplier

Sometimes miring through a lawsuit, whether against a supplier or an ex-business partner, can be more painful than the events that gave rise to the dispute. Although favorable results can never be guaranteed, foreign clients can take comfort in the fact that retaining a Chinese-based firm is less ta...

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Starting a Business in China: How and Where to Start

Right now, small and medium sized entrepreneurs can operate in the P.R.C. more confidently than ever. The Chinese government has committed itself to the protection of foreign partners’ investments, profits and legal rights. These guarantees protect against nationalization and uncompensated takings.  If you want to start a business (aside from merely setting up a representative office) there are three basic vehicles: (1) wholly foreign-owned enterprise; (2) joint equity venture; and (3) cooperative venture.  Whether you want to start an import-export store, boutique shop, hotel, restaurant, or establish a representative office, you must become familiar with relevant operating requirements.

As you can imagine, the new era has brought about a substantial amount of new regulations. The World Bank’s Doing Business Report provides a great starting point for newcomers to the P.R.C. http://www.doingbusiness.org/data/exploreeconomies/china/starting-a-business. The report provides a generalized framework, providing fees and time frames; but nevertheless, professional help should be consulted.

Should you choose to “go it alone,” your main ally will be the State Administration of Industry and Commerce’s (SAIC) website: http://www.saic.gov.cn. There you can find English translations of highly useful laws on advertising, consumer protection, and business associations (incorporation law). It is a good idea to become familiar with these primary sources before you seek counsel. The more you know, the better you can communicate your precise needs to Chinese professionals.

SAIC is where you will obtain your business license. You will need pre-approval of your business name, which usually takes around two weeks for a decision. You will need to open a Chinese-based bank account, subject to a minimum capital deposit. (The requisite funds and percentages required by each foreign partner or shareholder depend on what business vehicle you have chosen). Although it is possible to complete these initial steps without professional assistance, P.R.C. law mandates a verification report prepared by a Chinese auditing firm.

Further requirements include registering with the local statistics bureau, police station, and taxing authority. Recent developments in social insurance have also obligated foreigner business owners to enroll with local career service centers and welfare centers, before hiring any Chinese nationals. These procedures can be tricky at first, but you should not feel discouraged. They are testament to the bright economic future of foreign direct investment in the P.R.C.,  AsiaBridge Law can help you ease through each step, comfortably and confidently.

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Why Should I Retain a Chinese Law Firm?

There are many benefits to hiring a Chinese law firm. Often times having boots on the ground is indispensable. Whether you are operating within Asia or abroad, it is always reassuring having someone on-site and ready to respond at first notice. Additionally, there are many procedures and functions that a foreign attorney, even with an international firm, simply cannot do.

You need competence in the drafting of documents and transactions—specificity is key. Although it may seem beneficial and expeditious to simply pull a template from the internet, even the most expansive generally-termed contract cannot herald what you have in mind. Every situation is different.

But beneath the obvious needs for a Chinese attorney (e.g., drafting bilingual contracts, advising on Chinese law, locally registering intellectual property) the benefits are legion. The rule of law is a burgeoning concept in China. There has never been a more commanding need for competent legal counsel.

Keep in mind, your presence may be required in China for business. During these times, whether you are looking for, or managing vendors, legal consultation is likely to be needed. For example, product safety is incredibly important. At home in the U.S., or in Europe, there is a distributor who is the importer of record and if anything goes wrong, the distributor absorbs liability (or at most shares liability). However, in China you are likely to be the importer of record. Even if you are completely unaware or detached of any wrong doing on the behalf of a supplier (e.g., labor disputes, product hazards) the local government may come after you. Do not rest easy when a factory manager tells you that they are “globally insured.” Consider for a moment, would a U.S. lawyer go after a Chinese-based supplier when there is a stateside defendant to go after? Generally, if you are a U.S. citizen (or even a non-citizen, but with “minimum contacts” in the U.S.) you are always amenable to U.S. jurisdiction. As the importer of record, YOU are directly liable. As such, liability comes with the duty to stay informed of the relevant laws of both the U.S. and mainland China.

Consider another case illustration: when dealing with electronics, whether in U.S. or Europe, you will be responsible for safety certifications. Even if the factory deems a product as CE or UL certified, you are responsible for staying abreast of the developments and changes with regulations (rubber stamps do not equal compliance). You may have had a great relationship with a genuine supplier for years, but regulations always change. In other words, no matter what, even if you have found a good apple supplier, they may, because of slight error, be out of compliance.

International shipping is replete with slight hurdles that can lead to costly delays. For example, your new product’s customs clearance might require additional paperwork and duties. A quick phone call to your Chinese-based counsel at the border can avoid lengthy and unnecessary delays.

For a moment, think back to Philosophy 101, in which you may remember Jeremy Bentham’s school of thought “Utilitarianism.” Among the many principles he espoused, the most relevant here is deterrence. Put yourself in the shoes of a supplier. If a supplier knows that you have retained local counsel, it is more likely than not that he or she will exercise more diligence and care throughout production as your response to any wrongdoing will be much more swift and efficient. Part of avoiding the most common mistakes in China is making yourself a hard target. This also includes educating yourself about both the remarkable benefits and the unfortunate realities of doing business in China. As mentioned before, even a great supplier might be mistaken. Thus you and your counsel’s fastidiousness may be mutually beneficial.

At times it may seem more convenient to hire a domestic, U.S.-based law firm. But consider this: even for the most basic tasks a U.S. firm might consider it more efficient to outsource its in-house responsibilities to a Chinese firm! With this in mind, it is logical to cut out the middle man and connect directly with the firm handling the matter. Another reason clients may hesitant to hire Chinese attorneys is that—well let’s face it—because it can be a daunting task connecting with a good Chinese supplier, it reasons that it may be just as difficult to find an effective Chinese legal firm. But keep in mind, the key is finding a firm that can communicate with not only you, but also with your associates.

With all the practical considerations, it is always nice to know that you have local support in such a great land for opportunity as China.

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