China, International Law

China Due Diligence? Good Luck With That...

How do you do get information on a Chinese company when certain private investigatory work in China is illegal?

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Looking to do business with a Chinese company? Want to know whether that Chinese company is worthy of your business and your trust? How do you do get information on a Chinese company when certain private investigatory work in China is illegal?

The first thing you should do is conduct a Chinese-language internet search of your potential Chinese counterparty. This sort of search is not likely going to be enough to make you feel good about going forward with a $10 million deal, but it frequently can give you enough negative information on your potential Chinese counterparty to convince you not to do any deal at all.

Next, do your due diligence the old fashioned way. Ask your potential Chinese counterparty to provide you with its government registration documents and, if relevant to your deal, its accounting and tax records as well….

What if your potential counterparty refuses to give you these documents? Walk away. In our experience, legitimate Chinese companies do not balk at providing such documents.

What if your potential Chinese counterparty does turn over these documents? Have someone who understands such documents review them.

And remember, anything and everything can be faked. Just by way of a few examples, the China lawyers at my firm have in our own research detected the following:

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  • Company claimed to have a multimillion-dollar account at a nonexistent bank.
  • Company documents showed a subsidiary in the Marshall Islands, spelled “Marshal Island.” It had no such subsidiary.
  • Company claimed to have a branch office in a particular city, yet the relevant documents for that office (including supposed government documents) were from the wrong province.
  • Company claimed to have been shipping out product on a ship that did not exist.
  • Company claimed to have won a lawsuit in the Supreme Court of a certain country (and even produced “the decision”), but there had never been such a case.

In doing China due diligence, you should bear in mind the following:

  • Construct your own fraud scenario. Ask yourself how the Chinese company could have staged everything it has shown you. Did it switch the factory signs before you arrived, so that it looks like it owns the factory, rather than someone else? Did it paint the old machinery to look new? Is the person with whom you are speaking really a PwC accountant, or just someone paid $100 to pose as one? We have encountered fake factories, fake lawyers, fake documents, fake accountants, fake foreigners, fake owners….
  • Focus on the operations. Look carefully at the Chinese company’s operations. Why does the company have only 100 boxes in storage when it claims to be selling 5,000 widgets a week? How can the company make 5,000 widgets a week with only enough of x material to make 100 total? Why did the company have a completely different set of employees on the same day and time two weeks apart? It pays to visit two or three (or more) times — a good fraudster can put on a show, but they are unlikely to be able to do it the same way each time. Watch for the subtle differences.
  • Get the official records yourself. Use your own people to get the Chinese company’s official corporate records from the official Chinese government sources. Though doing this is neither inexpensive nor easy, information gleaned from the official government records can often be helpful. Then compare the official records with the documents the Chinese company gave you.
  • Take company-provided introductions with a grain of salt. Speak with your target Chinese company’s vendors, neighbors, employees, and customers, especially those you find on your own. When talking with people to whom your target Chinese company has introduced you, take everything that is said with a grain of salt. It is not difficult for an unscrupulous company to buy someone’s loyalty for the duration of a meeting or a phone call and this sort of thing goes on all the time. And again, do you really know whether these people are as claimed?
  • Speak with the Chinese company’s competitors. Competitors with real businesses can and usually will tell you about their competitors, but, of course, any information gleaned this way should be taken with at least a bit of salt as well.
  • Do not delegate. Use your own trusted network to gather information on your potential Chinese counterparty. If you don’t have such a network, get one. If you can’t get one, don’t do the deal.

I could go on and on….

For more on how to do due diligence on Chinese companies, check out the following relevant posts from my China Law Blog:

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Dan Harris is a founding member of Harris Moure, an international law firm with lawyers in Seattle, Chicago, Beijing, and Qingdao. He is also a co-editor of the China Law Blog. You can reach him by email at firm@harrismoure.com.

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