Doing business in China – With rewards comes risks

Keen to strengthen ties with the world’s fastest-growing economic juggernaut, Canadian business all too often gloss over the risks and exposure of doing business with Chinese suppliers. Risk management is frequently eschewed, due diligence shirked, and contracts inadequately drafted.

“What is so surprising is that in Canada even small business would not conceive of entering into a relationship without having a contract, yet when we go into China we lose our minds and don’t undertake the due diligence because we are so eager to have the business relationship,” observed Cyndee Todgham Cherniak, a leading lawyer in international trade.

Yet taking steps to mitigate risks makes sound business sense, particularly since the potential for disputes arising in fast-paced and emerging markets such as China is high due to distance, cultural and language differences, added Cherniak, who represented the Government of China, Chinese Associations and exporters in the three of the first four anti-dumping and countervailing duty cases against China.

A case in point is the Mega Brands case. When Blue Box International Ltd., a Hong-Kong-based toy manufacturer with several plants in China, sued Mega Brands for failing to pay for product that had been delivered, the Canadian firm successfully argued that the Chinese supplier failed to fill orders that led to lost sales during the 2004 holiday season. Indeed, its case hinged on the contract it signed with the Chinese supplier. In the end, Justice Claudine Roy ruled that Mega Brands suffered $1.34 million in lost profits on more than 95,000 units Blue Box failed to deliver but ordered the Montreal toy company to pay $420,000 for product that was delivered. (Blue Box has filed leave to appeal before the Quebec Court of Appeal. The case is expected to be heard sometime next year.)

“This was a contractual claim,” said Peter Kalichman, of Irving Mitchell Kalichman of Montreal, who represented Mega Brands. “The two parties contracted, had an agreement on how product was to be manufactured, how much, when it was to be delivered – and one of the parties failed to fulfill its obligations.”

While not necessarily the exception, the solid contract Mega Brands had with its Chinese suppliers is far from the norm. Though there is an “increasing awareness of the critical nature of good contracts,” many Canadian firms still rely on poorly-drafted contracts or even on the printed terms of their invoices, which can be exceedingly difficult to prove they are part of the contract, notes James Klotz, co-chair of the international business transactions group at Miller Thomson LLP in Toronto.

“The best reason why you have a contract is so that everybody understands what everybody is supposed to be doing,” said Klotz, who has written several books on international business law for both lawyers and business persons. “The more you spell it out, the less likely there is going to be a dispute. That means that longer contracts are called for. Unfortunately in those countries, longer contracts are typically not the norm. And quite frankly, Canadian companies don’t necessarily like long contracts either. They’re expensive.”

It may be tempting to require offshore manufacturers to enter into formal contracts containing provisions such as proof of insurance, exclusive jurisdiction and choice of law clauses in order to protect the purchaser, but it may not always be the most judicious course to take.

Canadian firms that rely on Chinese firms to ship goods into Canada should have proof of insurance clauses, which requires the Chinese business to prove that it has proper liability insurance, with adequate limits, said Cherniak. But a growing number of Canadian companies are preferring to receive goods freight on board or at the Chinese factory gate, in which case the Canadian firm is responsible for the insurance coverage, because if anything happens to the goods “they’re the ones who have the direct relationship with the insurance company,” added Cherniak.

The same holds true for exclusive jurisdiction and choice of law clauses. It may be appealing to include provisions that would grant Canadian courts with the exclusive forum for resolving disputes under the contract, but it may not be the strongest remedy. Even if the Canadian plaintiff is awarded judgment in Canadian soil, there is the sticky issue of how to enforce the award, particularly if the Chinese supplier does not have any assets in Canada.

“It all depends on how the supplier sees their prospects of doing business in Canada,” said Klotz, who represents Canadian and multinational enterprises in all areas related to international business transactions. “If the Canadian business is not that important to them, they may take the position of come and get us if you can. But that’s not an uncommon response in lesser developed countries.”

A more astute posture would be to examine all of one’s options, said Cherniak. In some cases, it would be shrewder to try and resolve the dispute before Chinese courts, in others before an arbitrator, and yet others to try and seek “a wise old sage” respected by the Chinese supplier to help to solve the problem.

“Canadian companies need to understand that the way of doing business is different in China,” said Cherniak, who also provides advice to Canadian companies doing business in China or with Chinese companies. “Canadian companies need to do their due diligence. We’re at a point in time where you shouldn’t just see the dollar sign. There should be additional steps taken to make sure that this is done properly.”