Spoke the other day with a French company that was contemplating suing a Chinese factory regarding bad product. This company bought about $350,000 in product it cannot use. When the French company told its Chinese supplier that it would be withholding its final ~$100,000 payment, the Chinese company said it planned to sue.

This French company was referred to us by another French company going through the exact same thing. Our phones are ringing off the hooks with these cases and they are not good.

Let me explain.

Chinese factories, particularly in certain industries like clothing, shoes, toys, and small gifts are hurting in China right now. This means many of these factories are cutting corners and much of the bad product in these cases is not due to bad production, but rather to bad components. The factory that makes the sweaters is using lesser wool to save costs and that doesn’t work. The factory that makes the shoes is using a lower grade leather and that doesn’t work. The factory that makes the plastic toy is using a lower grade plastic. And on and on and all this without giving any advance notice to their American or European buyers. Quality fade is most definitely on the rise in certain sectors in China.

But it gets worse.

In the old days when a Chinese factory provided bad product, it would usually eventually admit it and blame it on either a subcontractor or a supplier.

Good Chinese product suppliers are usually very busy and they often subcontract out to lower quality suppliers. We have handled many cases for foreign companies that received bad product from their previously reliable suppliers and in well over half of these cases, the product quality problems stemmed from the supplier having subcontracted out the manufacturing. The supplier usually freely admits to having subcontracted the work and sometimes even boasts that the problems otherwise would never have occurred. The supplier admits legal responsibility for the quality control problem, but then almost always proposes remedying it by giving a small discount on future orders until the damages from the bad product have been covered.The foreign company is usually in no mood to continue doing business with the offending supplier and wants only a monetary remedy. However, because the profit margins at most Chinese manufacturers are so low, they often simply cannot pay all of the damages caused by the bad product and a standstill results that can only be resolved through litigation.

Those were the good old days.

Today the standard Chinese factory tactic is to deny any problem and threaten retribution if they are not paid whatever is still “owed” it by their foreign buyer and to threaten to prevent the foreign buyer from “ever doing business in China again” or, more specifically, to seize the foreign company’s product at the border. Our international manufacturing lawyers take these threats seriously and they have altered our approach to these sorts of cases.

In the past, if a foreign company was seeking $200,000 in damages from a Chinese company for bad product, we would most of the time seek to dissuade them from even bothering to pursue litigation. Our thinking was that unless they have a well-crafted China Manufacturing Agreement that makes clear the requisite quality and the penalties for not meeting that standard, pursuing litigation in China would just not be worth the time, money and hassle. And suing in the United States (or in any other country whose court judgments are not enforced in China) typically made even less sense. For an explanation as to why this is usually the case, check out Suing Chinese Companies in US Courts.

But the strategy changes if the Chinese company threatens to close you down. We have dealt with cases where foreign companies were unable to buy from any Chinese supplier without paying 100% upfront because their alleged failure to pay had caused China’s export insurance agency — Sinosure — to refuse to insure payments from the US company. We have also dealt with way more than our share of cases where someone or something from our client was held hostage in China to secure payment.

If a foreign company is facing the situation above, our advise is usually to have them sue the Chinese company somewhere so as to be able to show Sinosure or the Chinese police or the Chinese border patrol agents that you have sued, which is usually enough to convince these people that the situation is not as simple as the Chinese company is making it out to be. Your lawsuit shows the Chinese company is not necessarily owed anything at all and that you are not clearly someone who does not pay your debts.

Of course, if your company has no intention of continuing to do business in or with China and your personnel will not be going there again, then the best strategy probably would be to just walk away, just as in the old days.

What are you seeing out there by way of payment threats and litigation?