Prevention of legal risks with foreign-related contracts

By Tony Zhang and Grace Zheng, Co-effort Law Firm
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When a Chinese enterprise enters into and performs foreign-related economic and trade co-operation in sectors such as import, export, outbound investment or participation in the invitation and submission of bids for construction of foreign projects, there are commonly various legal risks, e.g. risks associated with the transaction counterparty, contract terms, contract performance, contract compliance, contract dispute resolution, etc. The authors of this article have carried out a brief analysis of the legal risks associated with transaction counterparties in the foreign-related economic and trade activities of a Chinese enterprise.

张振安 TONY ZHANG 协力律师事务所高级合伙人 Senior Partner Co-effort Law Firm
张振安
TONY ZHANG
协力律师事务所高级合伙人
Senior Partner
Co-effort Law Firm

Do not credulously trust the partner. A certain large company proposing to purchase a mine in Turkey needed to co-operate with a Turkish company in establishing an equity joint venture and then execute a mine transfer agreement with the owner of the mine, in the name of the joint venture, to ultimately achieve its objective of acquiring mineral resources.

The authors, as legal counsel, issued for the company the corresponding Turkish mineral resource investment legal assessment report and recommended Turkish lawyers with whom we have had a long-term co-operative relationship. However, for a variety of reasons, the company did not engage a Turkish lawyer to provide the relevant legal services and registrations for the establishment of the joint venture; instead, “fully” trusting the Turkish partner, it authorized the partner to carry out all registration and other such procedures.

Half a year after the establishment of the joint venture, we inquired about the registration of the company in Turkey and learned that it had not engaged a Turkish lawyer at any point during the registration process. As the official language, Turkish, is understood by few people in China, the authors repeatedly reminded the company to retrieve the relevant company registration documents and information. It was found, after review, that the Chinese company was not registered as a shareholder of the joint venture (i.e. the company was not an investor in the joint venture), having been cheated by the Turkish partner. As the issue was discovered and remedied promptly, the Chinese company did not suffer a real loss, but if not for repeated reminders, the consequences could have been too dreadful to contemplate.

郑蕾 GRACE ZHENG 协力律师事务所高级合伙人 Senior Partner Co-effort Law Firm
郑蕾
GRACE ZHENG
协力律师事务所高级合伙人
Senior Partner
Co-effort Law Firm

Prudent selection of a partner. What an enterprise needs to keep in mind is that, in the course of co-operation with a foreign partner, it has to timely understand the counterparty’s credit standing to avoid business risks arising from too easily trusting or erroneously trusting such party.

If the payment method provided for in the export contract is advance T/T or deferred T/T, particular attention needs to be paid to the transaction counterparty’s credit standing. (T/T means telegraphic transfer; the term advance T/T means payment of all monies before the goods are shipped, and deferred T/T means the opposite.) A common occurrence is that, at the beginning, since the transaction amounts are relatively small, the foreign party, to demonstrate or show its economic strength, will go 100% for advance T/T, that is to say it will pay the entire amount before the goods are loaded on board.

Then, with the increase in the number of transaction contracts between the parties and the transaction contract amounts, and with the Chinese export enterprise’s growing trust in the foreign company, that company will progressively ask the export enterprise to provide it a line of credit of a certain percentage and commit to an increase in the number and amounts of orders. In this way, when the snowball of accounts receivable has reached a certain size, if a problem arises in the foreign party’s credit situation or an unexpected financial crisis or other such uncontrollable factor occurs, the foreign party may default, at which time the Chinese enterprise’s loss will be much larger.

Chinese export enterprises often encounter such a situation. They have to pay special attention to knowing the transaction counterparty’s business position and creditworthiness at all times to effectively control new credit risks and avoid greater losses.

Paying attention to sleight of hand in shell companies. In practice, certain enterprises will, with a view to guarding against the occurrence of legal actions or disputes, or to avoiding legal risks, establish a company in Hong Kong, the Virgin Islands, the Cayman Islands, etc. to carry out capital operations, or to put up a firewall. Such situations are not uncommon in practice and enterprises need to pay full attention to them.

For example, a certain US company named ABC Corporation has a good co-operative economic and trade relationship of long standing with a certain Chinese steel tubing enterprise, but a contract dispute subsequently arises between them. The Chinese party prepares to institute a legal action against the US company, however, when retrieving the information on the US company’s business licence, it discovers that the company changed its name to ABC Company Limited several years previously. This places the Chinese steel tubing company in an extremely passive position in its efforts to protect its rights.

Surprisingly, during the many years of trading with the US company, the Chinese company never noticed the change in the US company’s name. If the counterparty had been asked to promptly provide its registered particulars every year, attention would have been drawn to that fact in the course of trading, or it might have been possible to avoid the potential risk of default by the counterparty.

SUMMARY OF EXPERIENCE

An enterprise needs to pay particular attention to the legal risks relating to a transaction counterparty. This column has enumerated the ways a few of theses types of issues are manifested, hoping to draw enterprises’ special attention to them, but the authors have not exhaustively listed the problems that could arise.

With respect to the legal issues that could arise in connection with a trading counterparty, the authors recommend that a professional lawyer be brought in early to prevent problems before they arise.

It is a professional lawyer that is required, not one who is there just for appearance’s sake. A professional lawyer will have real-world experience, and with his or her intervention in the contract negotiations it will be possible to avoid the risks that could exist in the transaction. It is particularly through a good understanding of the credit standing of the transaction counterparty that it is possible to avoid the occurrence of careless errors, and avoid the occurrence of unnecessary losses.

Tony Zhang and Grace Zheng are senior partners at Co-effort Law Firm

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