Risk Mitigation EU SME Topics

It depends. Different payment methods have different levels of risk. The safest payment method depends on the nature of your relationship with your partner.

If you are a European SME selling to China, the safest option will be to request an advance payment, before the goods are actually shipped or services provided. The problem is that your Chinese buyer will not be very willing to do so as this option is the riskiest for them. The second-best option would be the letter of credit (l/c) – a document issued by the importer’s bank guaranteeing full remission of the transaction amount. The problem is that the bank would charge a percentage of the transaction amount, and that the process is very formal and requires a high degree of attention when drafting the terms of the transaction. If you are selling to a long-term and trustworthy partner, then documentary collections would be an interesting option as they are less formal and flexible. Lastly, EU SMEs should avoid open account payment methods.

The above process, however, is reversed if you are a European SME importing from China: your safest option would be an open account, followed by a documentary collection and then a letter of credit; you definitely need to avoid paying in advance.

At the EU SME Centre, we receive, on a weekly basis, emails from European SMEs which fell victims of scams by Chinese sellers/buyers. In nearly the totality of cases, scams can be avoided by taking very simple steps to conduct due diligence on the company: practical tips to avoid such scams and to minimise risks will be provided in specific FAQs in the “Legal and disputes” section.

Due diligence is essential. The only way to reduce risks is to spend time and resources to scrutinise every aspect of your potential partner’s business, to verify that the potential partner is legitimate and properly established, has a solid financial foundation, and is operationally capable of fulfilling your needs. Searching the company on web engines is not enough, although some potential red flags may already be triggered in this way, for instance if the company is not easy to find, or if there is no Chinese version of the website (indicating the legal Chinese name of the company). Other key steps include:

• Ask for a copy of the company’s business license.
• Verify the validity of the information included in it, e.g. the company’s tax number and whether the name and business scope showed on the business license perfectly matches that used in the business contracts. IMPORTANT: in China, company names in English have no legal value! Only those in Chinese do.
• Verify whether your contact person is allowed to negotiate on behalf of their company.
• Verify that the bank account provided belongs to a bank in the same jurisdiction of the company, and it does not belong to an individual.
• Verify the company stamp (chop): Chinese legal chops have a standardised shape, i.e. circled, red, with a star in the middle; other shapes of chops are not valid (see FAQ “How can I know if the chops used by Chinese companies are valid?).
• Avoid paying in advance, and instead use safer payment methods such as letters of credit which are commonly used in China (see FAQ “Which is the safest payment method to use in transactions with China?”)
• If possible, visit in person the premises of your partner and conduct an on-site inspection of the goods before they actually leave the Chinese port. Alternatively, third-party professional agencies may be contracted for this purpose.
• Finally, get in touch with the embassy/chamber of commerce of your country in China for further advice.

The EU SME Centre receives, on a weekly basis, emails from EU SMEs that have been scammed when purchasing goods from China. In the majority of cases, such scams could have been avoided with the above steps. The EU SME Centre can assist in conducting free-of-charge, informal background checks on potential partners. For major transactions and complex deals, it is always recommended to seek professional legal advice from law firms established in mainland China.

According to China’s Law on the Laws Applicable to Foreign-related Civil Relations, the Law on International Economic Contracts, and interpretations of the Supreme People’s Court, the two parties of a contract may choose in autonomy the laws applicable, provided that there is a clear foreign-related element in the relation between the two parties (which is always the case for contracts involving SMEs based in Europe); and that the application of foreign laws will not damage the social and public interests of China.

It is noteworthy that the Chinese judicial system has improved significantly in recent years for commercial and IP dispute resolution. EU SMEs therefore should not have any prejudices against the choice of Chinese law in their business contracts. In addition, choosing Chinese law might be more effective in enforcing one’s right in case of commercial disputes with Chinese companies, such as credit collection or compensation. If a Chinese company does have assets abroad, choosing the law of the foreign country could also be an option; but if it has no assets abroad (such as in the case of Chinese suppliers selling via online B2B e-commerce platforms), choosing Chinese law might be more advisable.

Finally, it must be noted that contracts between two domestic parties in China cannot choose foreign law as governing law. Affiliates of European companies operating as legal entities in mainland China are considered domestic entities and therefore cannot choose foreign law.

The EU SME Centre has received a few enquiries from EU SMEs which were asked, by a Chinese business partner (buyer), to pay notary or other administrative fees before or after signing a business contract. The fees would not be paid directly to the notary, but to the local Chinese company which would in turn ‘arrange’ or ‘take care of everything necessary’, sometimes ‘showing good will and accept to share the fees together’.

According to Chinese law and regulations, there is no mandatory provision to notarise ordinary sales and purchase contracts. This requirement exists only for some contracts of special importance, as for example real estate transfers. An excuse commonly used by such “partners” is to pay a fee that is required for applying to foreign currency exchange in the local bank: in practice, such fees do not exist.

In one specific case received, one EU SME received an unsolicited request from a Chinese company for the purchase of some products. The contract signed indicated that ‘notary fees’ and ‘foreign currency exchange fees’ would need to be shared by both parties to validate the contract. The EU SME paid the fees to the Chinese company, which then disappeared without proceeding with the purchase of the EU SME’s goods as agreed.

Therefore, when asked to pay any kind of notary fees or other administrative fees, European SMEs should immediately be suspicious!

The EU SME Centre receives, on a weekly basis, emails from EU SMEs that have been scammed when purchasing goods from China. In the majority of cases, such scams could have been avoided with the above steps. The EU SME Centre can assist in conducting free-of-charge, informal background checks on potential partners. For major transactions and complex deals, it is always recommended to seek professional legal advice from law firms established in mainland China.

In China, company stamps (chops) are essential for any business contract – much more than in the EU. They are a symbol of the legal rights of the company. Therefore, there are strict rules for their usage and storage. Chinese company stamps have standardised elements which are clearly identifiable (with very rare exceptions):

• Circular or oval shape
• Red ink
• Red star in the middle
• Company name written in Chinese characters
• Occasionally, bilingual chops in Chinese and English might be used; a 13-digit number might also appear, indicating the chop’s registration number with the authorities.

Company stamps in any other shapes, sizes, colours or languages have no legal value in China. One may argue that other chops – especially those in English – are used to facilitate the foreign partner’s understanding of the stamp; in practice, these are often a strong indicator that the company does not want to disclose its legal information and thus may have something to hide. In all the cases of scams encountered by the EU SME Centre, the company chops used by the Chinese company were clearly of different shapes, sizes, colours or languages!

The EU SME Centre receives, on a weekly basis, emails from EU SMEs that have been scammed when purchasing goods from China. In the majority of cases, such scams could have been avoided with the above steps. The EU SME Centre can assist in conducting free-of-charge, informal background checks on potential partners. For major transactions and complex deals, it is always recommended to seek professional legal advice from law firms established in mainland China.