The Importance of Legal Due Diligence

Lylian Zhao   |   March 26, 2020
Lylian Zhao, Director at Beijing Jingsh Law Firm Shenzhen Office

Each year, thousands of international buyers attend the Canton Fair to explore one of the largest consumer markets in the world. Kim was one of them.

Kim, who owns a manufacturing business in the Philippines, was looking for qualified Chinese suppliers at the 2017 Spring Canton Fair. Eventually, he found Chen and after some negotiations they decide to work together.

For the next two years, Chen’s factory supplied parts to Kim’s business. The quality was reliable and the delivery had been smooth. From August 2019, however, issues began to appear with the quality. Then one day, Kim made an advance payment to Chen, but Kim was not able to contact Chen at all. It was at that point that Kim came to me for legal advice.

When I first received Kim’s call, I discussed the issue with my colleague Tina, who was working on a similar case. We both agreed that differences in culture can cause misunderstandings in communication, and litigation is not always the only way to deal with these kinds of situations.

I started by researching Chen’s factory. According to the records with the Shenzhen Municipal Market Supervision and Administration and also the National Enterprise Credit Information Publicity, the factory was properly registered with transparent disclosure. There was no large amount of debt and Chen was the legal owner of the factory.

The next day, I visited Chen’s factory. I was surprised to find that the desks were dusty and there was no electricity or running water. As Kim’s attorney, I explained the situation to Chen. Chen told me that his factory had been scheduled for demolition and he was currently involved in a civil lawsuit to appeal the decision. The demolition was at the request of the local government, however, and so the lawsuit would involve government agencies.

According to my experience, I told Chen that he could not wait until his factory relocated to fulfill the outstanding orders. The lawsuit he was involved in would take a lot longer than he expected. If he did not communicate with his customers, he would be facing more charges from breaching supplier contracts. That was the moment that Chen needed to mitigate loss, to negotiate, and to bear responsibility before it was too late.

In the following weeks, after several mediations, Kim and Chen reached an agreement. As a substitute for the products that Kim had ordered but Chen did not have stock of, Chen sold Kim stock of similar products that he did have at a much reduced price. Both parties were satisfied with the outcome.

When it comes to supplier contracts, international buyers are mostly concerned about products and delivery dates, while ignoring other important factors. In this case, the factory itself. Therefore, I strongly suggest that international buyers conduct legal due diligence before signing a contract. It is a simple step that reduces a significant amount of risk, while also bringing long-term stability to the business relationship.

Lylian Zhao with her colleagues at Beijing Jingsh Law Firm Shenzhen

This conflict occurred at the end of 2019 and was finally resolved in early 2020. What urged me to write this story, however, is the COVID-19 pandemic.

This disaster is like pressing the pause button on the world. Every country has introduced various restrictions to stop travel and the speeding train that is international trade has grinded to a sudden halt.

Under such circumstances, many Chinese suppliers cannot deliver orders on schedule while some Chinese customers cannot pay in time after receiving goods. This has led to me receiving a few arbitration cases regarding international trade.

According to Chinese law, force majeure applies to this pandemic. Force majeure refers to a situation that cannot be foreseen, is unavoidable, and is insurmountable. According to Chinese law, it can be used as a condition for exemption. Yet, not every situation can be understood in this way – such as payment arrears and contractual obligations not affected by the pandemic – and force majeure clauses in international trade are not applicable to all situations.

Force majeure should be clearly stated and defined in the contract, so that the party in breach of the contract can be exempted from liabilities in the case of an event such as this pandemic. The difference in legal understandings of force majeure between two parties can often lead to disagreement. Due to the pandemic, is it more important now than ever to give timely notice through proper legal means and to effectively resolve conflicts.

In any culture, the most important thing is mutual understanding. Litigation or arbitration should be the last resort. I hope that this pandemic will pass soon and we can go back to our normal lives.

Lylian Zhao with her colleagues at Beijing Jingsh Law Firm Shenzhen

If you ever find yourself in a similar situation or need some advice on trade or business disputes, please do not hesitate to contact us here at Beijing Jingsh Law Firm Shenzhen for expert legal advice.