Loss Prevention and Safe Sourcing

Legal Disclaimer: 

The article below was created with the help of the following contributors:

  • www.Glo-bis.com    Experts in Due Diligence. Under contract with the US Government and corporation to spot scams and evaluate overseas partners.
  • www.AsiaBridgeLaw.com ‘s network of English-speaking, Chinese lawyers in China.

SupplierBlacklist.com (SBL) does not provide services nor represent the attorneys/service providers mentioned on this page and website. SBL, its staff (including volunteers) and associated companies, disclaims all liability for any loss or damage arising out of or in any way related to interactions with these 3rd parties.

 

How To Safely Place an Order with A Chinese Supplier: 5 Simple Steps

Who should read this article?

The 5 steps explained below are designed to protect international companies who are purchasing more than $2,000 but less than $200,000 worth of goods per order, direct from a Chinese factory, trading company or exporter.

For orders over $200,000, some additional precautions, beyond the 5 steps, are recommended.  Please consult a China-based, English-speaking lawyer for support..

 

 

 

 

 

Executive Summary

When buyers list bad suppliers at www.SupplierBlacklist.com they also explain what went wrong and state what they would do differently.  By analyzing these buyers’ experiences over 1000’s of listings, we have created a simple & effective 5 steps process that will help you avoid scams and source safely from China. This article, updated in 2022, explains the 5 steps for safe sourcing in detail:

 

#1: Do due diligence to confirm the seller is legit.

#2: Use a formal purchase contract.

#3: Match up seller’s bank account to the contract and the business license.

#4: Link payments to performance.

#5: Register your Intellectual Property before you contact anybody in China (if you have a unique product or brand to protect).

Bonus #6:  If the deal is too good to be true, it is probably a scam.  No matter what you heard on the internet, it is not possible to buy authentic Western brands (like Apple or Gucci) direct from “the factory”!  High risk product categories include raw materials, computer components, used heavy equipment and anything Covid related, especially PPE.

 

How To Safely Place an Order with A Chinese Supplier: 5 Simple Steps

Step #1: Due diligence to confirm the seller is legit.

When we talk about verifying the legitimacy of a supplier in China, we have two types of assessments in mind.

Level 1: Scam Assessment:  Is the company real?

Level 2: Corporate Assessment:  Who owns the company? Does the seller have a good reputation? Are they financially stable? Do they have experience exporting the specific product you wish to buy?

The obvious first step is to do a search of www.SupplierBlacklist.com to see if your potential Chinese supplier is an active scammer or underperforming supplier.  But don’t stop there.

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 rather than what is really happening.  So, visiting the factory can be a real eye opener.

  • Do they actual produce the product you wish to buy?
  • Are they a real supplier with staff and assets or are they 2 guys operating out of a warehouse pretending to be a factory? If the supplier gives you a bunch of excuses because you can’t visit the factory, it is safe to assume they are hiding something.  A real factory will be happy to show off their production line.  Scammers prefer smoke and mirrors.

If you don’t have the ability to visit the factory in person, consider engaging an independent 3rd party.  Simple factory audits only cost a few 100 USD and you are crazy to skip this step.  If you are saying to yourself, “I don’t have the budget to do quality control, let alone due diligence or written contracts”, then you probably shouldn’t be buying direct from China.

Tip 1: 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.  More on that later in this article.

Tip 2: While you, or a representative, are visiting the supplier, ask to review the written quality manual.  More on this later in the article.

Pay a few hundred bucks for an independent due diligence report.

These reports can be conducted over the course of a few days by professional researchers, and the supplier won’t know they are being checked out.

 

How To Safely Place An Order With A Chinese Supplier: 5 Simple Steps

Step #2: Have a written contract, even for small orders.

A well-prepared contract shows the supplier that you care about the details and aren’t a “push over”.   More importantly, a good contract provides a remedy if anything should go wrong. Doing business in China without a contract is akin to parking your car in public with a broken window and your wallet on the seat.

Most buyers are smart enough to list the pricing & product description in the purchase contract, but if your contract doesn’t cover the following essential items, you don’t have real protection:

  • Quality Standards
  • Lead Times
  • Penalty Clauses
  • Defect Management & Warranty
  • INCOTERMS & Payment Terms
  • NNN (non-compete, non-circumvention, non-disclosure)
  • Appropriate Official Language & Jurisdiction
  • Authorized Signatures (Chops)

 

Are English language supplier contracts legally binding in China?

An English-only document signed by both parties is legally binding, even in China. But it is bad idea to have an English only contract with your Chinese supplier.

  1. The seller may not even bother to translate it. They simply agree to the English version in order to get your order.  From day 1 the two sides are going in different directions.

  2. Keep in mind that to litigate outside of China is for the most part meaningless. The vast majority of Chinese companies do not have any assets outside of China and a court in China does not enforce foreign judgments, so wining in your home jurisdiction often means that you actually get nothing (except a bill for wasted legal fees).  If you want real protection, in the vast majority of cases, it is best to select the jurisdiction where the seller has assets, and that means China.

  3. If your key documents are in English, it complicates things a lot. For example, before the courts can make a decision, the English documents/ supporting evidence will need to be translated into Chinese by a court approved translator for the court’s review. This can be expensive and very time consuming. Plus, the Chinese side can employ the stall tactic of fighting over the accuracy of the contract translation rather than the violation of the contract. It’s much better to have your Chinese attorney structure the contract as a bilingual document rather than hope the court’s translation will be accurate. Be safe- use bilingual contracts.

How To Safely Place an Order with A Chinese Supplier: 5 Simple Steps

Step #3: Match up seller’s bank account to the contract and the business license.

Make sure the official name of the seller on the contract matches the name on the bank account where you will send money.  The name should also match the business license.  If you send money to one account and sign a contract with a different legal entity, good luck getting your money back if things go wrong. Many buyers don’t pay attention to the details and end up sending money to a private account or to a holding company rather than direct to the factory. Another big mistake is to assume the English name of the seller is legally binding.  The English name is just for marketing as only the Chinese name is considered the official name on record with the Chinese authorities. You can’t sue some company named “Best Good Star Mfg.” But you can sue “最好星有限公司”!

 

How To Safely Place an Order with A Chinese Supplier: 5 Simple Steps

Step #4: Link payments to performance.

“I’ll pay you after you put the order on the ship” gives a false sense of security for the buyer because the seller can ship you a container of rocks!  Payment terms can be structured in a way that they are safe for both sides.

A Chinse supplier will probably ask for 100% payment in advance. You probably want to pay after the goods are delivered.  Find middle ground that is fair to both parties. For example, “30-40-30”. Under 30-40-30 terms, the initial 30% of PO value is given to the supplier as a deposit. This allows the supplier to buy materials and lock in the price (especially important if you have a long lead time or deal in materials which face great price fluctuations, or example metals.)

The second payment of 40% is paid just BEFORE the order ships, AFTER independent quality inspection takes place.

The final 30% is transferred to China once the goods have arrived at the destination and a post-shipment inspection has taken place.

Let’s look at this 30-40-30 from both the buyer’s and seller’s perspectives to find why it was an acceptable middle ground.

The seller is worried that the buyer will default on payment. So, getting 70% (40+30) before the goods leave port limits their exposure. As the average factory in China makes between 10 and 30% mark up, the 70% covers at least the majority of their internal costs, so even if the buyer defaults it won’t put the seller out of business.

The buyer’s biggest concern is that the goods will have quality issues or not arrive at all. By holding out on the final 30% until delivery, the buyer has leverage if quality problems require re-work or replacement parts. It is also important to remember that the 40% is not paid until the buyer or the buyer’s representative inspects the goods in China. Don’t be stupid and accept the supplier’s internal quality report without independent verification.

 

How To Safely Place an Order with A Chinese Supplier: 5 Simple Steps

Step #5: Register your Intellectual Property before you contact anybody in China (if you have a unique product or brand to protect).

 

Since registering IP is fast and affordable, the US buyer should move quickly to cover their bases in China by engaging a legitimate, well-seasoned IP lawyer in China.  At that point, things start to look a lot better for the US company.  Non-Chinese entities have the right to own IP in China. So, it is not like you have to be Chinese or even be in China, to own IP in China.  Furthermore, US companies are likely to get a fair shake in a Chinese court (and even with an Alibaba help desk peon) when the US company can show proof of IP ownership in China with PRC government issued paperwork to back it up.

Register your Intellectual Property in China before you even start to source here.

China is a first to register rather than first to market system. That means that if you have a cool logo or design and it has not been registered in Beijing, then anybody can register it and you would have to pay them to get it back.

Even if everybody back home and in China knows you are the originator of that brand or IP, you will still be fighting a steep uphill battle in China if you fail to register it first. In China, it doesn’t matter who had the idea first, it only matters who registers it first!

Assuming you register in advance in China, a Chinese court will give even foreign companies a fair shake. In the past few years, the legal system in China has made great progress and there is much more of a level playing field when it comes to the courts.

 

How To Safely Place an Order with A Chinese Supplier: 5 Simple Steps

Conclusion: Do it right or don’t do it

Based on analysis of the 1000’s of listings at www.SupplierBlacklist.com, it may sound counter-intuitive, but smaller orders are actually more dangerous than larger orders because too many small size buyers don't put proper protections in place. So, it is very important, especially for the small buyers, to be serious about the 5 steps:

#1: Due diligence

#2: Legally binding contacts

#3: Confirming contract matches bank account matches business license

#4: Link payments to performance using a pre-shipment inspection

#5: Protect Intellectual Property before contacting suppliers

 

The 5 steps do not take much time or money to implement and you can "DIY" if your budget is tight. If you prefer to outsource the work to professionals, know that in our experience (at time of writing in 1/2022):

  1. Basic due diligence from a reputable research firm costs less than $200
  2. Pre-shipment inspections performed by a reputable independent quality control agency cost less than $300 in most parts of China.
  3. While is can cost over $500 to hire an English -speaking Chinese lawyer to draft a simple bilingual supplier contract, the money is well-spent as you can use that contract template over and over again with multiple suppliers rather than hiring a lawyer each time.
  4. Registering Intellectual Property in China is fairly straight forward and fees substantially lower than in the US and Europe.

Given the low cost to do things right and the high likelihood of getting ripped off if you don’t, we hope you will follow the “5 steps to safe sourcing” and never have a need to list a loss or report a bad supplier to www.SupplierBlacklist.com!