China Law Blog

There ought to be a law against quoting Peter Frampton twice in one week.

The other day, I did a post on how to know, in a blink, whether the factory with whom you are contemplating a business relationship is a good one. We received some comments with such excellent additional gut-check type indicators, I felt a second post was warranted. So here goes.

Ted Cruise recommends the following:

-- Check the lunch of the employees. Most businesses provide lunch and small increases in cost give large improvements in food quality. Some businesses feed their employees lunch to the tune of 1 RMB a day. you wouldn't feed that stuff to your dog. At 5-8 RMB a day you get very tasty and nutritious food. For many factory workers this may be the best meal of the day. Ask their food cost.

-- Does the manager know the employee's names?

-- What is the supervisor/worker ratio? A ratio anywhere near 5-1 indicates that the workers are disposable and need to be closely supervised. Likely this means no training. Any ratio over 15-1 indicates better training and a need to retain employees longer. Ask about the training program.

-- Safety and hygiene: are basic safety features in place? Do you see signs of work related injuries? Do you feel sick after spending time on the production floor? Do the employees seem healthy?

I wholeheartedly concur. All of these essentially get at one point: how does the company treat its workers. I remember once visiting a factory in Yantai owned by one of my firm's Chinese clients. I was shocked at how nice the facilities were for the workers. They lived in what appeared to be a very new, very well constructed high end building. The first floors of the building were offices, with living quarters above. During our meeting, the executives bragged about the perks they gave the employees (high quality lunches, a large game room, vans to take them into town when they wanted to go). I asked what they gained by providing all this to their employees and their immediate response was "good employees." I buy it. This is one of the better run companies with whom I have worked, anywhere.

Jared checked in with another one I love:

One other qualifying factor I often use is comparing the owner's car to the investment in technology/quality. If the car is much nicer than his factory investments, I tend to find the factory is not worth my business in the long run.

Again, I completely agree. Even though I am from Michigan (you know Michigan, that's the state where the US used to produce cars) and love cars, there is such a thing as excess and I have been to Chinese factories where the owner's new $150,000 car is parked out front and the factory is filthy and run down. The conclusion to be drawn there is that the owner is not trying to build up a business for the long haul; he is in it for the quick bucks.

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There is a strange dearth of materials out there for foreign companies seeking the nuts and bolts of how to get into selling their products online in and into China. I was recently alerted to an paper written on this very subject by Lisa Conklin, for her MBA degree at Fudan University. I enjoyed the article and thought it would be helpful to our readers and so I requested Ms. Conklin get it up on the internet to facilitate my linking over to it. That has been done and if you click here, you will see the article, entitled, "Chinese E-Commerce 2008: An Introduction and How-To for US SMEs." [pdf]

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I am always touting Malcolm Gladwell's book Blink. Reduced to two sentences, its thesis is that we humans overly worship logic to the detriment of our gut instincts, which are actually based on our lifetime of experience. In other words, your initial feeling about something is far more accurate than you think.

Quality Wars has a Gladwellian post up on Chinese factories, and I like it. The post is entitled, "How to FEEL a Good Factory - 5 Non-Traditional Indicators" and its thesis is, essentially, that you know one when you feel one.

More specifically the post calls on considering the following five non-traditional indicators:

1. Does the factory staff/management take home the leftover food if there is any after a restaurant meal? If you have traveled to China on business then you most likely have had a nice meal with a factory owner or other staff. Those that take home the leftovers get big kudos in my book. This is a behavior which represents frugality and good sense over losing face.

2. How do the factory workers’ bathrooms look? China factory floor bathrooms are notorious (as are other country’s). Is there a decent effort by management to keep them sanitary and minimize the stink? This represents placing value on hygiene which will most likely translate into production practices.

3. How easy is it to get to a desired person by phone when you call the factory? For any size business, being able to connect with the right person, quickly by phone, represents good organization and management. Test this by calling the factory reception.

4. At meetings and meals do more junior staff speak up and seem knowledgeable? Promising young talent at the factory is a sign of a healthy working environment. So is management that respects junior staff and encourages them to be heard.

5. How do you feel when you walk in the factory? When you visit the factory, how do you feel in that first 5 minutes when you arrive? Do you feel comfortable and like you’re working with people you can trust? There’s no substitute for gut feeling.

I am going to quibble a tiny bit with numbers 1, however, because in this period of super-tough times, my fear is the factory owner who scoops up leftovers is doing so out of economic desperation, which may lead him not to deliver you your next order.

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There is an old joke about a United Nations family planning conference. A leader up front, trying to scare people about overpopulation, exclaims how there is a woman giving birth somewhere in the world every 3 seconds. A jokester at the back of the room stands up and says, "find me that woman!" I thought of that joke today.

All Roads Lead To China just did a post entitled, "A Question of Chinese Toy Factory Closures," in which he asks all sorts of questions as to why so many Chinese toy factories have closed down when China's overall economic statistics are still not all that bad. The post asks the following of those factories that have closed:

1) How many of these factories existed 6 months ago vs. which ones were brought online to cope with the Christmas rush? 2) How many of these factories closed due to the fact that many brands have been reducing the number of suppliers they use? 3) How many of these factories were really viable entities that competed in the market vs. those that simply were producing low end commodities that were uncompetitive? 4) How many of these factories were simply “shacks out back” vs. well capitalized?

All Roads goes to great lengths to emphasize that he is not minimizing the economic troubles of China's factories, and I emphatically make that same statement. But, and I know this is going to sound strange, I have been asking my firm's China clients just about every weekday for the last month how they have been impacted by the Global and China downturn and not a one of them has mentioned factory closings. Indeed, I have asked many of them if they have experienced any problems from factory closings of their own or of their suppliers and the only response I have gotten is "no."

So yes, like All Roads, I absolutely believe factories are closing in China and with that, massive worker and community dislocation. But also like All Roads, I have very real questions as to what sort of factories those were.

What are you hearing/seeing out there?

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Just about every week, my firm gets contacted by a US company that ordered product from China and never got anything or got something multiple levels of magnitude less than what they ordered. Much of the time, this is a first order from China.

The US company is usually asking us what they can do to recover and most of the time (because the amount at stake is too little to hire an American law firm), I tell them to keep trying to recover and to retain a Chinese law firm to assist. I also tell them not to order from China again without knowing exactly from whom they are ordering and without having someone on their side monitoring product quality. I also suggest they have a contract on their next go round that will increase the likelihood of their getting good quality and decrease the degree of difficulty in their recovering if they do not.

David Dayton over at the Silk Road International Blog, who knows as much about the nitty gritty of Chinese factories as anyone, just did a post setting out possible reasons why US companies so often get bad product on their first go round with Chinese companies. This post is an absolute must read for any first timers thinking about buying product from China. It also will likely confirm a few things for veteran China buyers as well. Entitled, "Ancient Chinese Secret: Don’t Lie (to foreigners), it’s just not worth it," I urge you to check it out.

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"Santa Clara" is among my Google alerts because my eldest daughter studies engineering at the University there. Friday, it was filled with stories of an engineer (apparently Chinese-American) who, after being laid off from his high tech start-up, killed three people at the company where he once worked. The story bothered me, but it did not worry me about my kid (who was in Palo Alto in any event) because these sorts of things are random and can happen anywhere. I drew no conclusions from these murders about Chinese-Americans, San Clarans, high tech workers, Californians, or we 300 or so million Americans.

But when one out of 1.3 billion Chinese loses it and commits murder, there are apparently all sorts of things we can and should extrapolate. In "Murder at the Drum Tower," Newsweek uses the knifing of the Minnesota couple inside Beijing's drum tower during the Olympics as evidence of China being on the verge of a total meltdown. The article tells us that the perpetrator, a Mr. Tang, was a wonderful, normal guy until China's many stresses rendered him unable to cope. Interestingly, his life is sounding much like that of the Santa Clara killer. 99 times out of 100, when someone goes berzerk, the first stories from the press include interviews from those who sorta knew the guy (and it's nearly always a guy) saying they never expected him to do this. Well of course. Who does expect someone to go out and start killing people for little to no reason?

Newsweek has this to say:

Back in August, Tang's ordinariness was cause for relief: authorities quickly figured out that he wasn't a terrorist, and the Games went on. But the truth is perhaps more disturbing. The country is the world's most stressful: three decades of reforms have shredded China's safety net and transformed society beyond recognition. That's why, as Chinese leaders prepare to mark the 30th anniversary of Deng Xiaoping's capitalist reforms next month, they're also frantically pumping more than half a trillion dollars into their economy in hopes of staving off a downturn.

They have reason to worry. Economists say China's GDP has to grow between 7.5 and 8 percent a year just to keep up with the need for new jobs. Labor unrest has already broken out across the country: half of China's toymakers have gone bankrupt this year, throwing millions of factory workers into the streets, while cabbies angered by gas prices rioted and burned police vehicles in Chongqing a few weeks ago. Tang shared their sense of frustration. Many who knew him are reluctant to talk about him publicly, fearing trouble with the authorities, and most requested anonymity before agreeing to be interviewed. But his story reveals tensions that seethe just below the surface in China.

Let's break this Newsweek story down and analyze it.

-- "Back in August, Tang's ordinariness was cause for relief: authorities quickly figured out that he wasn't a terrorist, and the Games went on. But the truth is perhaps more disturbing." So in August, China was glad he was not a terrorist, but now it would prefer that he had been? That is ridiculous.

-- "The troubles that destroyed Tang—the loss of his job, the collapse of his marriage, heartbreak over his wastrel only child—are all too common across China." Hey 24 year old Newsweek reporter, these troubles, to one degree or another, are the worry of about 90 percent of all adults all over the world. Big deal.

-- "The country is the world's most stressful: three decades of reforms have shredded China's safety net and transformed society beyond recognition." Is this made up out of whole cloth or is there any evidence to support this? I thought recent surveys were showing the Chinese to be among the most content with their lot of any people in the world. Guess those must have been in August.

-- "That's why, as Chinese leaders prepare to mark the 30th anniversary of Deng Xiaoping's capitalist reforms next month, they're also frantically pumping more than half a trillion dollars into their economy in hopes of staving off a downturn." So the Chinese government is pumping money into the Chinese economy to relieve stress? If that were true, why is it not allocating any money for psychological counseling? It is true that the government is concerned that a poor economy will work to erode its perceived legitimacy, but the idea that is seeking to relieve psychological stress is bizarre.

-- "They have reason to worry. Economists say China's GDP has to grow between 7.5 and 8 percent a year just to keep up with the need for new jobs." This is what I have read elsewhere and I do believe the government is concerned about this for reasons of governmental stability.

-- "Labor unrest has already broken out across the country: half of China's toymakers have gone bankrupt this year, throwing millions of factory workers into the streets, while cabbies angered by gas prices rioted and burned police vehicles in Chongqing a few weeks ago." First off, labor unrest was prevalent in China well before August and that was one of the main reasons China enacted its new Labor Contract Law earlier this year. Second, it is sheer hyperbole to say that the bankruptcies of China's toymakers have thrown "millions of factory workers into the streets." Most of China's toymakers did not file bankruptcy, they just shut down. A legal point, I know, but it further evidences the unbelievable lack of care that went into this article. Third, it is a gross exaggeration to say these workers were thrown into the streets. This implies homelessness, and it is my understanding that most of these workers found new jobs or returned to their villages. I am not trying to minimize the impact of losing one's job here, but let's keep it in perspective.

-- "Tang shared their sense of frustration. Many who knew him are reluctant to talk about him publicly, fearing trouble with the authorities, and most requested anonymity before agreeing to be interviewed. But his story reveals tensions that seethe just below the surface in China." Again, these sorts of "tensions" seethe just below the surface in just about every country on earth. So what?

The implication of the article seems to be that China was better off during the iron rice bowl years, and maybe it should return to socialism.

What do you think? What is Newsweek's agenda here?

UPDATE: The always sensible (and I mean that in the same way my grandmother meant it in referring to the white shoes she would buy) ImageThief just ran what I see as a somewhat parallel post on the so-called furor regarding Gong Li's having become a Singaporean citizen. In his post, "Pardon me, but who gives a damn about Gong Li anyway?" ImageThief refers to a TimesOnline story talking up the fact that China "branded" Ms. Li a traitor. ImageThief rightly points out that one can find any viewpoint on China's internet and that most Chinese probably do not care one way or the other about Gong Li's current passport:

All of which is scholarly good fun, but ignores the biggest point: Who besides undersexed dorm-crawlers gives a damn what Gong Li does? Imagethief is willing to bet that if you stopped Chinese people at random on the street in Beijing and asked them how they felt about Gong Li taking Singaporean citizenship, the most often expressed sentiments would be, "Huh?", "How can I do that?" and "Who are you and why are you talking to me?" Not necessarily in that order.

Extrapolating from niche internet musings is not all that different from extrapolating from one murderous nut jobber.

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The Green Leap Forward recently did a comprehensive overview of the Singapore-China eco-city going up on a massive scale just outside Tianjin. If you have any interest in eco-development, you should check it this post, entitled, "Creating A Better Life: A Closer Look at the Sino-Singapore Tianjin Eco-City Project."

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The China Observer blog has been up for about two months now and I have already become a regular reader. The blog is written by Joel Backaler, who describes himself as follows:

Joel Backaler (周乐达) first traveled to Beijing in 2001 and has since returned to the capital city where he works as the only non-Chinese analyst for a leading multinational IT and management consulting firm. Joel has accumulated over six years of China market experience through positions in venture capital, new media entrepreneurship, independent consulting and research.

Joel holds a Bachelor of Arts degree in Economics and East Asian Studies from Connecticut College. He was awarded the prestigious U.S. State Department sponsored Fulbright Fellowship to work and study in Taiwan. Upon completion of his Fulbright grant Joel studied under the academic year program at the Stanford/IUP Center intensive language training program hosted by Beijing’s Tsinghua University.

Joel is a native English speaker. He speaks, reads and writes fluent Mandarin Chinese; and is conversationally fluent in Spanish.

Joel is using his blog to chronicle what he is seeing in China, which is "the next big thing":

China is the next big thing.”

Every visit home, friends and family all make the same observation: “You’re in the right place. China is the next big thing.”

When asked why, most offer anecdotal evidence about China’s rapid economic growth and the outsourcing of American jobs. They just don’t get it.

Back in Beijing, I am surrounded by many friends and colleagues, both expat and Chinese, who do get it. Like me, these dynamic and diverse professionals live in China and understand the language, culture, and business environment. Innovators write blogs about the latest happenings, emerging businesses and all aspects of China’s ongoing transformation. Silicon Hutong, China Digital Watch, and China Law Blog are just a few of my favorites.

What is missing, however, is a bridge connecting these two groups (what I define as Outside Observers and Inside Observers). Someone to take key local observations from within China and share them with the greater global community. The China Observer Blog presents readers with the essential information on companies you need to know, best business practices and cultural factors that drive the Chinese marketplace. Only through analysis of these factors can one begin to truly understand why and how the focus of the global economy has shifted away from the U.S. and other traditionally “strong” economies.

* * * *

The ultimate goal of The China Observer Blog is to educate and offer readers a source of current and comprehensive information about the business world in China. My aim is to be an educator across borders and cultures. In today’s business world, if you don’t know about what is happening on the ground in China, then you will inevitably be left behind.

Yes, I agree: China really is “the next big thing.” I don’t feel this way because of what I have heard from the mass media, or because of the stories I’ve been told by friends impressed by China’s dramatic growth. I base my opinion on first hand observations made while living here in China. The China Observer Blog presents these local observations to you and gives you the opportunity to see what today’s China is really all about.

Despite Joel's gargantuan ambitions for his blog (ah, youth), of which I do not believe any one blog can achieve, the blog does fill a very nice niche. Many of the posts start with Joel's observing a China business or industry, then explaining how that industry works in China and what we can expect of it in the future. He does this with China's online gaming industry, China's plastic surgery industry, and China's beauty products industry, among others. To complement his industry observations, Joel also throws in an occasional post on what I would call the cultural ramifications of technology in China.

I urge all readers to check out The China Observer.

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Years ago, I wrote about how I ended up on the same Asiana Airlines Qingdao-Seoul-Seattle flight as a long-time client and friend of mine whose company, among other things, had been hugely successful in China in an industry where just about every other foreign company had failed. The long flights gave us an opportunity to talk without my meter running (that's a joke, people) and we talked a lot about business in China.

He told me about one of his offices in a third tier China city and how he was running it. He loved the manager there and had given this person full hiring and firing authority and a cut of the rapidly increasing profits. I asked about the manager's salary package and when I learned it, my eyes bulged. I commented that they could be paying this guy half as much and still getting the same effort out of him. My client vehemently argued against me, using a whole arsenal of weapons. He said I was wrong, that he did not care, and that I was applying an employer mentality completely different than the one I used for my own law firm. He actually went a long way towards convincing me, and a couple of years later (after two of my firm's other clients had told me that this one company was the only Chinese company from whom they would buy this particular product, even though it cost more) I was completely sold.

I thought of that plane ride today after reading an excellent post at the heretofore undiscovered (by me anyway) but exceedingly informative blog, China Manufacturing Leadership. (h/t to China Economic Review Editor's Blog) The blog is subtitled, "facing new challenges with practical strategies" and though it is geared towards China manufacturing, many of its posts are writ large. In his profile page, the blog's author, David Levy, describes his blog further as being "all about the changes that China-based manufacturing executives and front-line managers must make in their leadership to optimize operations in the face of the upcoming challenges."

Levy's most recent post is entitled, "Coming to China, but NOT for cheap labor: Obsessing about cheap labor without considering overall value can be pretty stupid," and he is right, of course. If cheap labor were everything, Afghanistan, Somalia, Yemen and North Korea would all be manufacturing centers and Germany and Japan would have no manufacturing at all. And certainly all China manufacturing would have long ago moved to Vietnam or Sri Lanka, as a few bloggers have been predicting.

Levy makes this point the best way possible, with a real world example of which he was an integral part:

About 10 years ago, I was hired as the sourcing director for ***** Electronics, a privately held company headquartered for over 40 years in southern California. We were a smallish power supply company, supporting OEM projects for some major players in the medical, commercial and sometimes retail electronics markets. We had no China facility, and relied on our Taiwanese suppliers to realize the designs, make the products and ship them to us. My job was to setup and run a small liaison office in Taiwan, managing the development and sourcing of power supplies with our Taiwanese OEM and ODM vendors, and ensuring the quality of products made by those vendors in their Taiwan and Chinese factories.

Previous attempts at outsourcing in Mexico had failed miserably, and now it was time to try Taiwan as a manufacturing center. Prior to my arrival, Taiwan wasn’t working either. It was clear that Taiwan wasn’t “working for us” because its factories in Taiwan didn’t have the quality understanding to satisfy our market’s demands, and their factories in China (where an increasing number of our products were being made) didn’t have the flexibility to “buy into” our high-mix low-volume high-value model. The results: projects sold to major customers got to market late, or never made it to market at all. Most damaging were product recalls for power supplies sold to Bloomberg and Kodak.

Various manufacturing and operational problems in Taiwan were proving insurmountable so the decision was made to go to the Mainland:

So it was decided sometime in 1999 that we would solve these problems by setting up in China. When I mentioned to our current vendors that we would be setting up in China, they tended to snicker as they mumbled “chasing cheap labor”. My dirty little secret was out, as if I’d winked while mentioning I was “going for a massage”,

This was when labor WAS still cheap in China, but cheap labor was not even CLOSE to being the driver for the move. This facility was set up (and remains) in Shenzhen city (in Nanyou), which is a much higher cost setting than where any of our competitors had set up (usually in Shenzhen’s outskirts, or in Dongguan). We paid our people more, and spent more on housing and other benefits than our competitors did (many called me stupid to do this, and warned me against “spoiling” the workforce).

What we chased, or what we caught, was a stable and flexible workforce. In retrospect, cheaper labor would have been much more costly. That facility, with it’s high labor costs, started on a shoestring budget, grew to take in all previously outsourced production, and grew an R&D function which was intended as a “back office” to the US R&D facility. In the end that too became the driver of our company’s R&D capability.

So we came to China and paid our workers too much, spent too much on their benefits and too much on ensuring their comfort and safety. And all we got for all this “cost” was LEAN, flexible, and otherwise value-added production. The value, added by this flexible and stable workforce, was not lost on the market, and as we added Fortune 500 companies to our customer list, our value and stature grew. Finally the operation was finally purchased by a competitor.

Levy has since left that company, but that company remains in South China and it never mentions "moving out of southern China to chase cheap labor."

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Very thoughtful piece on The Hypermodern on how China cannot take its position and status in the world for granted. The post is entitled, "The Loss of Soft Power," and it is well worth a read.

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For years, China gave partial to full VAT (Value Added Tax) rebates on many of its products shipped out for export. Recently, however, China had begun to reduce and/or phase out many of those rebates. On November 1, 2008, China's State Council reversed itself and raised tax rebates on 3,486 items. Today, it announced that come December 1, 2008, it will be increasing tax rebates "on 3,770 export items, or 27.9 percent of all products shipped by China." (h/t to 3PL Wire)

The price of product from China just went down. Again.

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The Joint US - China Cooperation on Clean Energy Forum (JUCCCE -- Is that pronounced Juicy?) recently ended and China Environmental Law was there and has posted on it, in its aptly named post, "The Morning After." This post nicely summarizes went transpired and links over to various other sites for those who just can't get enough clean with their tech.

The post includes the following money quote, which near as I can tell from the many clients of my firm that are in the China cleantech business, could not be more true:

China will continue to be a “pilot program” heaven: if you have a technology, product, or service, you would like to test in a low-cost environment, you will probably be able to find a partner in China (as long as it doesn’t cost them anything) to help you test it. But remember, China still doesn’t have that IP protection thing down pat yet.

Do check it out.

UPDATE: In its post, "JUCCCE Clean Energy Forum–Closing Summary," The Green Leap Forward,' provides a transcript of the excellent and inspiring (that is the first time I have used that word on this blog) closing speech by Julian Wong, who is the author of The Green Leap Forward.

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So maybe spending three days with the in-laws in rural Central (a/k/a downstate) Illinois has diminished my faculties a bit (certainly having to use dial-up AOL did affect my mood), but what I saw there, along with my conversations with fellow blogger, Steve Dickinson, who just returned from Wuhan, China, have convinced me that Wuhan is the next Central Illinois.

First a bit about Central Illinois.

I was mostly in Peru, IL, population <10,000. Peru was a typical Midwestern US industrial town. Its largest employer had been Westclox, whose closure in the 1970s devastated the local economy. Nothing had really replaced it. As I near Peru, I always tell everyone to set their watches back twenty years.

But this time, things were very different. Peru is in the midst of remaking itself.

Peru is located on I-80, which links the West Coast to the East Coast. If one were to weight each mile of I-80 based strictly on population, I am guessing Peru would fall pretty close to the middle. It is also very close to countless other major highways, close to O'Hare airport (the second busiest US airport), near various train stations, on the Illinois River, and right in the heart of US industry. In other words, it is perfectly located in terms of logistics.

Peru is now taking advantage of its central location, along with its relatively low labor costs, and it (and the entire area surrounding it) are becoming distribution centers for countless mega-retailers and manufacturers.

Wuhan, sometimes referred to as "the Chicago of China," is doing the same thing. As Rich Brubaker of All Roads Lead to China points out in his recent post, "Building Out Wuhan to Its Fullest Geographic Potential," Wuhan, has a lot of "advantages" relating to logistics:

-- It is logistically in a great place with air, rail, national highway, and river transport options all intersecting - in a single location. -- It has a strong history of industry -- It has access to a lot of locally sourced raw materials

My firm represents a number of freight forwarders and they are always telling me of how easy it is to move product into and out of China through its major cities, as compared to moving product within China. This makes sense as China has for the last thirty years emphasized its export sector. However, even before the global slowdown and China's recently announced stimulus package, China had begun to increase its emphasis on boosting its domestic economy. Now, with an obviously more pressing need to drive its own economy, and with the announcement of an economic stimulus package that calls for greatly increased spending on infrastructure, we should expect to see cities like Wuhan increasingly come to the fore. Wuhan is perfectly positioned to take advantage of both China's increased infrastructure spending and its slow conversion to a less export reliant economy.

And it already has high speed internet....

UPDATE: I see that Asia Logistics Wrap just did a post on China's increased infrastructure spending, entitled, "China's Bailout: Accelerating Logistics Infrastructure Investment." The post has an interesting graph comparing the cost of moving goods as share of GDP as between China and the United States.

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The following is Steve Dickinson's second day report from the 2008 Maritime Conference he is attending in Wuhan, China.

Today I acted as the moderator (in Chinese) for a series of presentations on ship financing. As with yesterday's discussion on shipbuilding, the presenters were mostly experienced lawyers from Hong Kong and Singapore. Much of the presentation dealt with technical issues related to the common law and international law of ship financing. However, the underlying key to the presentations was:

-- Ship financing is the foundation of the ship building, ship conversion and ship sale business.

-- Traditionally, banks have provided this financing. Alternative forms of financing exist, but have never worked well in the maritime business.

-- The current financial crisis has virtually closed the door on traditional bank financing. This door will remain closed for the near future, possibly as long as one year.

In my role as moderator, I then posed the following questions/comments to the speakers and to the audience:

Steve: The shut down in bank financing will have a severe impact on the Chinese shipbuidling/shiprepair industry, right? Answer: Correct.

Steve: Historically, in the U.S. and Europe, when worldwide bank financing dried up, local banks usually stepped in to provide financing. Are Chinese banks stepping in to fill the financing gap? Answer: No, they are not. Chinese banks have no appetite for risky loans right now. Further, they do not understand international ship financing and they have no real desire to learn.

Steve: It appears China's shipbuilding industry is taking a passive approach to both the contract default and financing issues. Answer: Yes.

Steve: It therefore appears China's ship building/ship repair industry will be heavily impacted over the next 18 months, with few companies surviving. Answer: The audience did not answer. The presenters agreed that this seems to be a reasonable conclusion. These Singapore and Hong Kong lawyers are therefore turning their efforts towards cementing their relations with Korean and other national shipbuilders they think will survive the current situation. Even during private discussions after the formal presentation, the Chinese company representatives remained silent about their plans for dealing with the key issues facing their industry.

It is not clear to me whether the Chinese industry will wake up to the situation in time to resolve the critical issues facing the industry. In the interim, however, it appears there will be some very good deals on new vessels from Chinese yards as customers begin to abandon existing contracts. I also think there will be very good deals on Chinese shipyards, many of which are state of the art. It is also possible, of course, that China will institute a stimulus package that will save at least some of its shipyards.

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CLB's own Steve Dickinson has just returned from the annual China Maritime Law Conference, made up mostly of China's leading maritime lawyers. This year's conference was in Wuhan.

Steve reports as follows after the first day:

I just finished the morning session of the first day of the All China Maritime Law Conference being held in Wuhan. The theme of this year's meeting is the shipbuilding industry. The conference was organized when Chinese shipbuilding was booming and China had plans to replace Korea as the leading shipbuilder in the world. Due to the recent economic downturn, virtually every presenter revised their presentation at the last minute to discuss the effects the current situation is having and will have on the maritime industry in China.

The presenters all agreed on the following. The downturn in shipping is having a profoundly negative effect on all segments of China's maritime industry.

Shipbuilders are finding that their shipbuilding contracts are being extensively breached. Since shipbuilders in China are mostly new companies, they are heavily in debt. These breaches threaten the life of the entire shipbuilding industry in China.

Vessel owners are finding that charter parties are refusing to pay charter payments. Some charter parties are demanding revisions to charter agreements. In more extreme cases, the charter parties are simply abandoning vessels in mid-voyage. [Editor's note: charter party agreements are essentially agreements to rent out a ship]

Shippers are finding that their customers are refusing to honor long term shipping agreements and are demanding extreme reductions in shipping rates.

Ports are finding their volumes rapidly decreasing. This is an especially serious problem with smaller and newer ports. It is also a problem with ports in the middle of ambitious expansion plans.

The presenters for this morning session were primarily from Hong Kong, Singapore and England. They proposed various legal solutions for dealing with the crisis situation that has developed. The Chinese lawyers in attendance spoke in near unison on the response they are getting from their clients:

The clients first deny there is any problem.

Once the problem is too acute to deny, the clients reluctantly consult with a lawyer on what to do. When told that they will need to retain and pay for a lawyer to pursue resolution of the issue, the client refuses. The reason: "We are already losing money. Why would we pay a lawyer and even lose more money?"

What does this mean for the future? It is possible the Chinese maritime industry will wake up and start to deal with the current situation. Currently, however, the Chinese maritime industry is taking a purely passive approach to the current crisis. Since the lawyers are all new to the industry, the Chinese lawyers have little perspective on what will be the result. The industry leaders are in the same position: they have no historical perspective. If the attitude of the Chinese maritime industry does not change, it seems likely there will be a major shake out, with many companies going out of business. Only the major players who are funded by the central government are likely to survive.

The other day, I wrote the following:

We are finding that Chinese companies, for a whole host of reasons, are incredibly slow to mount full scale efforts to collect on their debts. Just this week, we were contacted by two Chinese companies seeking to collect 6 and 7 figure amounts from American companies arising from long ago non-payments. In both cases, the Chinese companies had waited so long that the US companies had already ceased operations, without ever having declared bankruptcy. Though it is sometimes possible to collect in such cases, there is a greatly increased difficulty to do so.

In response to this, someone left a comment, asking the following:

Were shipbuilders that flush for that long that they could ignore 6 and 7 figure outstanding debts owed them, and for so long?

My response to that was going to be to analogize it to the dot.com boom. During the boom, companies were moving forward so fast, seeking and getting funding, and burning through cash at such a fast pace, that nobody had any time or desire to focus on bad debt. When the dot.com boom ended, however, many companies came to us with a whole host of international bad debts for us to collect on. We had one client come to us with a very fresh debt of around $300,000 from a company in Europe. We were able to recover most of this on our client's behalf and after we did so, they came back to us with two more matters: one for about a million dollars and one for about $700,000, both of which were more than two years old and both of which were with Russian companies that turned out to no longer exist. I asked the client why they had waited so long to come to us with these and their response was that the money just never seemed to matter when they had so much of it.

Just today, my firm secured a Rule B arrest Federal arrest order to arrest a Singapore-owned vessel for failing to pay on its charter-party contract and spoke with a Chinese company seeking our help in collecting on a nearly million dollar debt on a vessel charter-party agreement. The Singapore arrest was for a British company that is paying us by the hour. The Chinese company was unwilling to hire us on either the hourly rate or the contingency fee basis we requested. It wanted us to pursue the claims for a 5% contingency fee, with my firm paying all the costs. I assured them that no firm in the United States, and certainly not one with attorneys and staff fluent in Chinese and Russian (the opposing party is Russian) would ever take on this case for anything approaching that amount.

Many years ago, another Chinese company insisted we take its case on a 5% contingency basis. That case was for around $400,000 and it too needed Chinese speaking lawyers. I knew the company that owed the money and thought the case was extremely strong, but refused to take it on anything approaching the terms sought by the Chinese company. The Chinese company rejected our terms and I asked Steve Dickinson what he thought the Chinese company would do. Steve told me he thought it would simply never collect the money. La plus ca change....

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So I just had an interesting conversation with a client today. This client manufactures really big things in China (sorry, I have to be so vague here) under his company's name and then sells these big things in the US. He was bragging about how good business has been for him lately. How can that be, I asked. Aren't your sales down? A little he replied. Around ten percent. Well then, why are you talking about things being so good? Dan, it's like this [recapped, not word for word]:

-- The cost of the materials for my product has plunged.
-- The production costs for my product have plunged.
-- My VAT rebate has increased.
-- I have been getting killer shipping rates. "Killer," he repeated, with obvious glee in his voice.

"So yeah, sales are down a bit, but my profits are up....you still serious about gathering up a buying expedition to Iceland?'

For more on the massive decline in shipping rates from China, check out, "The Impact of the Massive drop in China Shipping Rates," at the For Sale In China blog."

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The 2008 China Maritime Law Special Topic Research annual meeting will be in Wuhan, China, this weekend, November 8 and 9. The conference will be at the absolutely gorgeous Shangrila Hotel in Wuhan. The meeting is jointly sponsored by the All China Bar Association Maritime Law Section, the Yangtzi River Maritime Law Association, The Hubei Province Bar Association, The Hubei Province Vessel Construction Trade Association and The Wuhan City Bar Association. This will be the first time this annual meeting will be held in an inland city.

The following topics will be discussed:

-- Legal issues relating to vessel construction.

-- Shipping contracts and customs issues.

-- Disputes arising from the release of cargo without a bill of lading (my firm is involved in a case on that in China right now)

-- Insurance issues arising from transport of dangerous cargo.

In addition to maritime lawyers, the meeting will draw attendees from all areas of legal and business life in China concerned with these issues, including judges from the Supreme Court and various Chinese high courts, together with representatives from the shipbuilding, marine insurance, shipping, logistics and freight forwarding industries.

This meeting was planned before the recent world wide economic downturn. This downturn has hit the shipping industry very hard, with dry bulk freight rates falling by over 80% in just the past two weeks. The decline in freight volume and rates is now having knock on effects in the shipbuilding industry. China is caught in the middle of this, since it has been rapidly expanding its shipbuilding capacity in an attempt to overtake Korea as the largest shipbuilder in the world.

China Law Blog's own Steve Dickinson has been asked to speak (in Chinese) to the group on the various issues raised by the economic downturn, particular with respect to shipping rates (defaults on shipping contracts) and shipbuilding (defaults on shipbuilding contracts).

One of the things Steve will be emphasizing to this very likely all-Chinese audience is the need to move quickly to collect on outstanding debt. We are finding that Chinese companies, for a whole host of reasons, are incredibly slow to mount full scale efforts to collect on their debts. Just this week, we were contacted by two Chinese companies seeking to collect 6 and 7 figure amounts from American companies arising from long ago non-payments. In both cases, the Chinese companies had waited so long that the US companies had already ceased operations, without ever having declared bankruptcy. Though it is sometimes possible to collect in such cases, there is a greatly increased difficulty to do so.

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Bear with me here non-lawyers as I promise there will be some manna for you at the end.

Just read a very good article in International Law Office by Harvey Lau of Baker & McKenzie (and no, my firm is not and has never been in merger talks with Baker & McKenzie, though we are honored by the rumors), on airplane seizures/arrests in China. The article is entitled, "Ratification of Cape Town Convention to Boost Finance" [free subscription required] and it talks about how "the National People’s Congress just ratified the Convention on International Interests in Mobile Equipment and the Protocol to the Convention on International Interests in Mobile Equipment on Matters Specific to Aircraft Equipment, known as the Cape Town Convention, which China signed in November 2001." This convention is expected to become law in China in early 2009.

So why am I telling you all this? Again, bear with me here.

The article describes how this ratification will better protect airplane lenders and thereby reduce overall lending costs:

The ratified convention will provide owners and mortgagees of aircraft equipment with better protection for their interests in terms of perfection and priority of such interests by way of registration, which will be welcomed by existing and potential financiers, leasing companies and other participants in the Chinese aviation industry. US Eximbank had frequently indicated that it would reduce its exposure fee for airlines in China were China to ratify the convention. Given the turmoil in the financial markets, financing structures involving US Eximbank's support may be revived and might again become one of the most popular financing structures in the Chinese market.

I am going to be deliberately vague here, but around five years ago, a vessel finance company client of ours came to us regarding China asset protection issues similar to those involved in this just passed convention We conducted massive China law research and, in tandem with our client, we all eventually decided the protections just were not that to warrant our client financing vessel building in China.

And now to the point of this convention. The point is that this is just the most recent example of China's bringing its business laws more in line with the developed world and China's recognizing the benefits of enacting laws that, at first glance may appear to disfavor local Chinese companies. China's business laws are maturing, giving further lie to the idea that "there are no laws in China."

What do you think?

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The Wu Way blog, provides the best analysis I have seen on how China views last night's election of Barack Obama as America's next president. The post is entitled, "How does China view an Obama Presidency…what does China think of Obama?" and it sees China (to the extent one can generalize about 1.3+ billion people) as "excited about the election as a historic moment, but also cautious in their concern that he may be more protectionist."

It is well worth a read.

UPDATE: China Beat also does an excellent job on this in its post, "Obama Elected, China Reacts."

FURTHER UPDATE: This does not exactly fit here, but I liked it so much and it is election related, so here goes. I just read an excellent article over at Spot-On, by Jeanne Jackson, entitled, "The Day After." The article, and, in particular, the following paragraphs, summed up better my feelings than even my own feelings, and certainly better than anything I could write myself:

Perhaps you are celebrating today. Or, perhaps, you are annoyed. I certainly hope, whether you backed the winner or loser, you are being gracious about the outcome. I will almost sell my first-born to purchase a one-way ticket for the first moron who sneers about moving to Canada because his candidate lost.

It is, perhaps, an old-fashioned idea, but I've always had a certain amount of respect for the office of the presidency, no matter who occupies it. Granted, over the centuries we've had our share of . . . um. . .characters. And, believe me, I've been a victim of presidential policy more times than I've benefitted.

But I am in awe of the process and its relatively peaceful outcome. I am in awe of the fact that there are two people willing to risk the biggest, most public of all losses and always do so with class and dignity. For that reason, I can't hate a president (though I can pray to a merciful God for deliverance from incompetence).

Damn, that's some good stuff.

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David Dayton over at Silk Road International sets out what every buyer of China product must do before buying product from or having product manufactured in China.

A summary of Silk Road's list:

1. Pay $150 or so and get a report on your company before you send any money over to China. David mentions using Verify or Glo Bis for this. These reports will usually tell you if the company to whom you are about to send so much money actually exists and is operating legally. I would also suggest that you do an internet search (in both English and in Mandarin) on the company from which you will be buying to see what others are saying about it.

2. Second, pay another $800 or so to get your factory audited. Dayton's company, Silk Road International, does this. The audit will confirm that the factory from whom you will be buying actually has the capability to provide you what it says it will provide you.

3. Get your potential supplier to give you the names of others, preferably from your own country, that ordered product from your potential supplier recently and then call and find out how it went.

Dayton then does a great job laying out the math on why this makes complete sense:

Now, maybe you’re saying: “Hey! I can’t pay and extra $1000 to just confirm what they already told me!” My response is: “What % of your order can be rejected and still allow you to still stay in business?” Yes, it’s that serious. Pay $1000 up front. Pay another $1000 for a few days of QC and you’ll not only be safe, you’ll be set up for your next order and you and your supplier will have standards set for the future. If you are ordering $20K or more, this should be an acceptable margin. And the next order you’ll only be paying $1000 for the QC. The opposite scenario is that you just trust your factory and send tens of thousands of dollars to someone you don’t know, have never visited and works in a very instable and opaque business environment. If the factory takes $20K and runs (and I’ve never had this happen to me, but I’ve heard stories) the $1000 will seem like small potatoes. If 20% of your order is junk, or if 100% just “off just a little,” but enough to make it a 2nd in your market, how insignificant is the $1000 pre-check now?!

4. Get "a lawyer and cover your legal bases in China before you send any info/spec’s/designs/art to China." Again, Dayton is right. We typically recommend that you secure a signed non-disclosure agreement (NDA) from your potential suppliers before you show them anything of any real import. This NDA should be in Chinese. We also typically recommend you register your intellectual property (IP) in China before you discuss it with anyone in China.

Even doing these four things will not guarantee you will succeed, but not doing them all but guarantees you will fail.

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