My friends over at the China Law Blog has a good post entitled China Manufacturing Payment Terms. Limit Your Risks. We find a similar situation occurs with goods manufactured in Korea, but the situation in Korea is less dire, than, in China, since Korea has a much more transparent legal system and much more efficient pretrial enforcement mechanisms.
The China Law Blog post notes that:
“Many companies continue to purchase container load quantities of product from small manufacturers located on the southern coast of China. This trade has developed a standard form of payment, often termed 30/70 TT. This means: 30 percent down payment on placement of the order, with the remaining 70% due upon shipment. This means 30% of the price is paid before the product is manufactured and 100% of the price is paid before the product is shipped.
Here are some common result of this system:
- Product arrives in the United States. Upon inspection, it is determined that a substantial percentage of the product is defective. The buyer demands a refund and the Chinese manufacturer refuses. In the alternative, the manufacturer offers a discount on the next order. If this offer is accepted, the buyer is forced to continue to do business with a manufacturer that makes defective product.
- The buyer arranges for an inspection during the production process or prior to shipment. The inspection reveals a substantial number of defects. The buyer demands a refund of the deposit and the manufacturer refuses, stating that they have already spent the deposit to manufacture the disputed goods. In the alternative, the manufacturer offers to correct the defects and provide a discount on the existing order. If this offer is accepted, the buyer is forced to continue to do business with a manufacturer that makes defective product.
The foreign (usually U.S.) company buying the product then contacts my law firm about filing a lawsuit against the Chinese manufacturer, rather than accept the unacceptable terms. In virtually every case, however, the buyer ultimately determines that the cost of litigation is not justified by the amount of the potential recovery. The buyer is then forced either to abandon the manufacturer and take its losses or accept the terms proposed and continue to work with a bad manufacturer.”
The China Law Blog’s answer for this conundrum:
- Do not make the second, 70% payment until after an inspection of the goods. In this way, the buyer’s risk is limited to the 30% down payment.
- Inspect the product as early possible. Time is a major factor in China business. If you find defects early, it is possible that you will be able to resolve the issue in time to save the shipment. If the issue cannot be resolved, then you at least can probably move on to a different manufacturer early enough to obtain acceptable product in time to meet your business needs.
- Treat the 30/70 TT method as the price for testing out the Chinese manufacturing system. As soon as possible, move to a different method of payment. Use one that does not require payment of any funds until after an inspection has been made. There are many alternative methods of payment in China. Of course, the use of such a method will require a quantity and timing commitment from the buyer that extends beyond the spot, single container type of purchase that is typical for the 30/70 TT method of payment. If you are not Wal-Mart, you are not going to get Wal-Mart like terms.
I completely agree with the assessment and the answer to the assessment, for Korea, but I would add that it is best to have someone on the ground in Korea to assist with the inspection when the products are being manufactured and, also, have a Korean-tailored agreement. Agreements may be less important in China than in Korea, thus, I agree that “foreign companies operating in China (replace Korea with China) must account for these risks in their business planning,” but, for Korea, I must note that the risk must, also, be reflected in the supply agreement, since Korean court system, often, is a useful tool for resolving disputes.
Other articles that may be of interest to the reader:
- Top 10 Mistakes of Companies Doing Business in Korea
- Korean Outsourcing: Legal Basics
- Top 10 Things to Do Before Manufacturing in Korea
Sean Hayes may be contacted at: SeanHayes@ipglegal.com.
Sean Hayes is co-chair of the Korea Practice Team at IPG Legal. He is the only non-Korean to have worked as an attorney for the Korean court system (Constitutional Court of Korea) and one of the first non-Koreans to be a regular member of a Korean law faculty.
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