Due Diligence and QC are important. Contracts are Essential.
Executive Summary: Initial productions runs in China are particularly challenging as there are so many unknowns. Distance and language complicate transparency. This is the story of a US buyer who did everything right in terms of due diligence and quality control. But for reasons beyond his control, the entire order was defective. They had the foresight to create a bilingual contract with the supplier. Without the contract, this would have been a total loss.
Background:
While this case study revolved around the purchase and delivery of made-in-China equipment to grind coconuts, the lessons learned and best practices implemented are applicable to a wide range of product categories.
This case study is based on an actual AsiaBridgeLaw client that was kind enough to allow us to make public what they did right as well as wrong. As you will see, they were very robust in their safe sourcing practices, yet the supplier still found a way to screw up the order.
Here are some of the key things that the buyer did right during the supplier selection and initial order phases.
- Proper due diligence and audit the top choices
- Know who you’re dealing with
- Get references from happy customers (and follow up with those references)
- Bilingual Purchase order contract
- Who are you paying? (Not a personal account!)
- Link performance to payments
- Do not make final payment until product has been verified, either in person or by a 3rd party inspection service provider
Let’s explain why each of the above steps are so important.
Importance of Due Diligence
Once you’ve done all the hard work to identify suppliers that best appear to meet your requirements for price, quality, and lead time, and have proven experience in manufacturing your product, you still need to ensure that you’re dealing with a legitimate company that is on sound financial ground. So proper Due Diligence is performed.
AsiaBridge Law’s Corporate Assessment (CA) and Red Flag Assessment (RFA) are the ideal tools for clients who are buying from Chinese suppliers. The CA is an affordable tool for clients who want viability into the stability, assets & reputation of a target company. The RFA will help you source safe, avoid scams and confirm that the terms of the deal are fair.
Another resource the client used was www.supplierblacklist.com. This is a free website where buyers are helping each other in their due diligence on Chinese suppliers (and other countries) by basically exposing suppliers that did them wrong.
The buyer even asked the supplier for a few references. They seller was able to provide a few happy customers and things were looking good.
When you’re ready to proceed with your order, make sure you have a proper bilingual purchase order and purchase order contract in place with your supplier.
Purchase Order vs Purchase Contract Explained:
In very simple terms:
Purchase Order (PO): Usually 1 Page that states who is buying what, when, under which payment terms.
Purchase Contract (PC): Usually around 10 pages. A bilingual document that defines the expectations of the buyer and details of the relationship with the seller. AKA “Purchase Agreement”, “OEM Agreement” or “Supplier Contract”.
Supplier Contract are Essentials
A bilingual contract should be as detailed as possible and at a minimum, define the following:
- Burden of Bank Fees
- Tooling Ownership Details
- Penalty for Missed Lead Times
- Defect Product Management
- Buyer IQC standard
- Required Documentation
- Hotline for supplier
- Code of Conduct for Vendors
- Statement on Changes
- Warranty Terms
- NNN (non-disclosure, non-compete, non-circumvention)
- Mutual Benefit Statement
Related Content: NNN vs NDA
Another smart move by the client was to get a copy of the supplier’s business license and include that along with the quotation from the supplier in the contract as well.
The client made sure the supplier signed off on the contract by giving it the “chop” and making it legally binding.
Related Content: How to make the contract legally binding in China
Also, very important--- know who you’re paying. The name on the factory door/ contract/ bank account should all be the same. If you send money to a personal account, but production takes place at a factory and you have a contract with a 3rd party sales team…it’s going to be a mess if you have to enforce the contract. In this case, the client followed our guidelines and structured the payments and contracts correctly.
If your product is custom designed or involves proprietary packaging or branding, you’ll want to be sure to have a proper NNN (non-compete, non-disclosure and non-circumvent) contract in place as well
What went wrong when this buyer dealt with China?
In the case of this client, the product was industrial machinery to process coconuts. As mentioned, they had done everything right. Proper due diligence on the supplier. Checked references. Signed bilingual contract in place. Final inspection to ensure the product quality was met before final payment was sent. Everything was looking good, until….
Pictures speak 1000 words.
Images were taken during final QC
Pre-Shipment Images
But here is what it looked like after 50 days on the boat from China.
So, what went wrong when buying this equipment from China?
The supplier, when confronted with the condition of the equipment upon arrival, admitted that after the final inspection and testing of the operation, they had not cleaned the machine and properly prepared it for sea freight as called out in the mutually agreed quality standards which were incorporated into the contract.
The machine did not operate properly and was going to cost the client a significant amount to replace the motor and cutting blades. Unfortunately, the supplier refused to accept any responsibility for this.
Next steps when your order from China turns out to be unusable junk and the supplier won’t fix things!
So even when you think you’ve though of everything, there are still plenty of ways the Chinese sellers can mess things up. That’s why is it essential to have a proper contract that protects your interests. In this case the supplier did not honor their obligations to resolve the situation as pre-agreed in the contract. AsiaBridge was hired to issue a demand letter and take the supplier to court, if needed, in order to cover the costs of direct and indirect loss to the client.
Bottom Line: You almost need to assume supplier will make mistakes, especially on the first order run. Having a solid contract will give you a much better chance of recovering funds if something unexpected goes wrong. In short- Due Diligence and QC are important. Contracts are Essential.
ABL Blog: Sr. Editor and Primary Content Creator: Michael J. Bellamy
Originally from Upstate New York, Mike moved to Asia in 1993 and is a China business advisor to both Fortune 500 companies and small businesses. Recognized as an expert on doing business in China, he has been interviewed by WSJ, CNBC, FT & Bloomberg.
A featured presenter on China issues at seminars, trade shows and corporate events across the globe.
Learn more about Mike and AsiaBridge Law at
https://www.asiabridgelaw.com/business-advisory-services/
Mike is the author of “The Essential Reference Guide to China Sourcing”
(available on Amazon).