To enhance procurement management by enterprises under the central government (central enterprises), the State-Owned Assets Supervision and Administration Commission (SASAC) of the State Council has been promoting a centralized procurement system since June 2012, pushing for a transformation in central enterprise procurement management, from the dispersed to the centralized. As pioneers in the development of the Belt and Road Initiative, central enterprises should pay close attention to the special legal risks accompanying centralized procurement.
Centralized procurement
In cross-border procurement for Belt and Road projects, the centralized procurement models are not completely identical, as there are significant differences in the industries in which central enterprises find themselves, and each of the internal management systems have their peculiarities. The usual practice is to establish a procurement monitoring centre at the group level, subjecting group procurement matters to centralized management and control, with one or more authorized trading platform companies in the group providing procurement services to group member enterprises.
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A platform company can participate in transactions in ways including: (1) the platform company, directly serving as the procuring entity, can carry out procurement by signing contracts in its own name, independently enjoying the rights and bearing the obligations towards the counterparties; (2) as a trading service provider, the platform company only enjoys and bears the rights and obligations of a trade agent service provider, e.g., being responsible for document review, customs clearance, duty and tax matters, but does not bear or enjoy substantive rights or obligations such as payment, manufacturing supervision, and acceptance; and (3) the trade agent service provider and actual procuring entity, as joint buyers, execute the contracts, and the platform company and actual procuring entity jointly enjoy the rights under the contracts and bear joint and several liability towards the seller.
Special legal risks
When carrying on its business, a trading platform company not only faces the various procurement risks that a typical trading company is required to respond to, but also the special legal risks arising from its connected relationships with group member enterprises.
Joint and several liability risk. As a connected relationship exists between the platform company and the actual procuring entity, when procurement is done through a trading platform company, the supplier, being in a stronger position, will usually require the platform company and the actual buyer to bear joint and several liability. Based on its connected relationship with the buyer, the platform company is usually compelled to accept the seller’s demands. This way of proceeding results in a sharp increase in the platform company’s legal risks.
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Litigation risk. Based on the bearing of the above-mentioned joint and several liability, the platform company could be implicated in a legal action. As the platform company is not actually involved in the specific performance of the trading contract between the buyer and seller, it is likely to find itself in a passive position in the event that it is implicated in a dispute. Once a dispute breaks out between the buyer and the seller, there is a possibility that the platform company’s accounts or assets will also be frozen by the court subject to the application of the seller, thereby affecting its normal operations.
Triggering of cross-default clause. A trading company that serves as a group’s procurement platform will often be offered a large amount of credit by a bank because of its large trading volume and the group’s credit allocation. Correspondingly, it will also undertake the functions of opening letters of credit, issuing letters of guarantee, or making advance payments for the group procuring entities. Credit agreements typically contain cross-default clauses: If a breach arises under the procurement agreement, or a legal action involving a relatively large amount arises, a default under the credit agreement could be triggered, resulting in termination of the line of credit, which could result in breaches under other procurement contracts.
Domestic and foreign compliance risks and blockage of procurement channels. In the procurement of special types of equipment, the extent of a platform company’s understanding as to whether the supplier and product involve sensitive information is limited. On the one hand, its qualifications and operating permits could be revoked for violation of domestic
import-export-related administrative reg-
ulations; on the other hand, against the background of the US-China trade war and the US government’s abuse of long-arm jurisdiction, high foreign compliance risks can arise, which can directly result in the whole group’s procurement channels being impeded.
Countermeasures
Division of dedicated procurement among multiple platforms. A central enterprise can establish several platform companies based on its internal business segments, type of product being procured, etc. Each platform company can better understand the product backgrounds and use demands of the procuring entities, as well as the market situation and market regulation situation in the relevant sector, thereby dispersing risks while effectively enhancing professional procurement capabilities.
Sound contractual terms. The trading platform company should ensure that the terms allocating the responsibilities of each of the entities to the transaction in the contract with the supplier are sound and, to the extent possible, avoid a situation in the transaction structure design and contractual terms where the platform company and the actual procuring entity bear joint and several liability. And it should add compliance terms relating to export controls, economic sanctions, anti-corruption, environmental protection, etc., to avoid a situation where no relief is available should the supplier breach its compliance obligations.
With global trade friction increasing, an enterprise should emphasize the continual improvement and optimization of contracts, which is the first line of defence.
Improvement of procurement compliance. With respect to the special risks faced by a trading platform company, they often rise due to the risks occurring under general trade, for example payment default. There are also such situations as a lack of clarity of responsibilities among affiliated enterprises in the performance of a contract, and denial of the independent status of a legal person. A trading platform company should strengthen oversight of the performance of upstream and downstream contracts to avoid special risks.
Wang Jihong is a partner and Li Chenxi is an associate at Zhong Lun Law Firm
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