10 Critical Steps to Avoid Business Scams in China

Chinese companies have gained global recognition for their capacity to provide a wide variety of services and goods at competitive prices. As business operations become increasingly globalized, more companies look to China for business solutions. However, dealing with international partners, particularly those based in China, can sometimes come with risks and uncertainties, including various business scams.

Just as with any business transaction, careful diligence and scrutiny are paramount. When it comes to Chinese companies, there are specific red flags and business scam alerts to be aware of. Below, we’ll delve into these issues, providing a comprehensive guide to ensure your dealings with Chinese companies are secure and transparent.

1. Identifying the Real Chinese Legal Business Name

Start by obtaining the company’s real Chinese legal business name, not the English version. Verifying its registration with the Chinese government’s official records is crucial to confirming the company’s legal recognition.

Obtaining the accurate Chinese business name allows for cross-checking with official government databases. This verification process ensures the company is legally registered and provides an initial layer of protection against fraudulent activities. Engaging with entities that are not properly registered or whose registration details are inconsistent can lead to significant business risks, including potential financial loss and legal complications.

2. Suspicious Contracting Practices

Be wary if a Chinese company suggests signing an agreement with a different company, particularly one based outside of Mainland China. For example, Hong Kong has jurisdiction and a legal system that is different from mainland China. A reluctance to use its own name on the contract typically signals possible fraudulent activity. Such an approach is often employed to sidestep liability, using a separate or third-party company to avoid legal consequences in China. Ensure the contracting company matches the official Chinese business name to avoid falling victim to scams.

Always insist on clarity and transparency in contractual arrangements. Request detailed explanations for any proposed changes in the contracting party and verify their legitimacy. Additionally, consult with legal experts on Chinese law to review and ensure the contract adheres to all legal standards and does not contain clauses that could undermine your legal standing.

3. Absence of Official Business Stamps

In China, business stamps (also known as company seals or chops) hold significant legal standing and are required on all official documents. If a Chinese company does not use its business stamp on agreements, it can be a significant warning sign. Verify that the Chinese legal company name and business number on the stamp are correct, ensuring they match the registered Chinese legal entity. Remember that legal names in China are in Chinese and not English. Proper use of the official stamp ensures documents are legally binding under Chinese law and helps protect against scams.

The business stamp acts as an official signature, conferring legal validity to the document it marks. Always cross-reference the stamp’s details with the company’s registered information. If inconsistencies arise, request clarification from the company or seek verification through official channels.

4. Verifying Business Licenses

Every legitimate company in China must have a business license issued by the Chinese government. The business license includes crucial details such as the company’s registered address, legal Chinese names of the legal representative and the legal entity, business scope, and registered capital. This step prevents dealings with unregistered or fly-by-night operations, which are common scams.

Inspecting the business license allows for verification of the company’s operational legitimacy and scope. Confirm that the company’s business activities align with what is stated on the license. If discrepancies are found, seek further explanation or consider it a red flag. Regularly update and maintain records of the verified business licenses to ensure ongoing compliance and legitimacy.

5. Investigating Capitalization and Ownership Structure

Examine the company’s capitalization, including funding sources, overall financial health, and the degree of leverage. A well-capitalized company is generally more stable and less likely to encounter financial difficulties impacting operations. Investigate potential conflicts of interest among company officials and shareholders. Check whether the owners have other businesses and scrutinize litigation records. A track record of lawsuits for contract breaches, intellectual property theft, or other legal issues could suggest unethical practices, putting your business at risk.

Understanding the ownership structure can reveal potential conflicts of interest or undisclosed affiliations. Analyze the financial statements and audit reports to assess the company’s financial health comprehensively. Look for signs of over-leveraging or reliance on unstable funding sources, as these could indicate financial instability.

6. Checking for Irregular Activities or Operational Issues

Monitor for signs of financial problems or mismanagement. If a Chinese company appears on the “irregular activities” or “operations canceled” list, it indicates involvement in activities that breach Chinese commercial laws or regulations. Various Chinese government websites and industry-specific regulatory bodies provide access to these lists, aiding in the identification and avoidance of potential scams.

Regularly reviewing these lists helps identify companies with a history of compliance issues or operational irregularities. Investigate the reasons behind any irregular activities listing and seek clarification from the company. Consistent monitoring and due diligence can preemptively identify and mitigate risks associated with partnering with companies that have a troubled operational history.

7. Assessing the Company’s Scope of Operations and Asset Holdings

Ensure the company’s offerings align with its officially sanctioned activities in China. Check their business license to see the nature of the business activities they are permitted to undertake. Investigate the company’s history to confirm it holds tangible assets and intellectual property. Companies with significant holdings in assets and intellectual property are generally less likely to engage in fraudulent activities and provide a form of security as assets can be liquidated to settle debts in financial difficulties. This assessment is crucial to protecting against scams that involve overrepresenting capabilities or assets.

Conducting site visits and engaging third-party audit services can provide a clearer picture of the company’s operational capabilities and asset holdings. Verify the existence and condition of physical assets, such as machinery and facilities, and ensure intellectual property claims are substantiated with proper documentation. Comprehensive verification helps prevent falling prey to companies that misrepresent their true capabilities.

8. Legal History: A Predictor of Future Behavior

A company’s legal history can serve as a critical indicator of its reliability. Frequent legal disputes suggest potential management or operational issues and unreliable business practices. Verify whether the company has been involved in intellectual property disputes, which could imply a history of IP infringement. Understanding a company’s legal history helps avoid scams involving repeated legal infractions.

Analyzing legal history involves reviewing court records, legal databases, and public filings. Look for patterns of litigation that could indicate systemic issues within the company. A transparent and clean legal history often correlates with more reliable and ethical business practices.

9. Evaluating Supply Chain and Production Capabilities

Before engaging with a Chinese company, thoroughly evaluate their supply chain and production capabilities. Visit their facilities if possible, or hire a third-party inspection service. Ensure the company can meet your production requirements in terms of quality and quantity. Verify that their suppliers are legitimate and compliant with relevant regulations. This due diligence helps protect against scams involving inadequate or misrepresented production capabilities.

Supply chain evaluation includes assessing the reliability and sustainability of suppliers, raw material sources, and logistics networks. Verify that suppliers adhere to industry standards and regulatory requirements. Implement quality control measures and conduct regular audits to ensure ongoing compliance. Establishing a robust and transparent supply chain reduces risks associated with production delays, quality issues, and supply disruptions.

10. Addressing Bankruptcy Risks in Your Contract

Bankruptcy is a serious concern when dealing with overseas companies. If a Chinese company files for bankruptcy and has assets, your ability to recover your investment may depend on the strength of your contract. Have a robust, China-specific contract in place before engaging in any business activities. Clearly outline the terms of your business relationship, including payment terms, delivery schedules, quality control measures, and provisions for financial distress or insolvency.

Stipulate that if bankruptcy proceedings are initiated, the assets pledged to your company will be used to fulfill the company’s obligations. Additionally, consider including an ‘advance payment bond’ in a China-specific contract adapted to Chinese laws and with the jurisdiction set to China. This type of security provided by the company’s bank guarantees the return of your advance payment should the company fail to fulfill its contractual obligations. Such precautions safeguard against scams exploiting financial distress to renege on agreements.

Engage legal experts on Chinese law to draft and review contracts. Ensure that all terms are clear, enforceable, and provide adequate protection against potential financial risks. Regularly review and update contracts to reflect any changes in business conditions or regulatory requirements, maintaining their relevance and effectiveness.

Conclusion

Following these detailed guidelines can mitigate the risks of engaging with Chinese companies, ensuring that your business dealings are secure and transparent. These precautions will help safeguard your investments and foster successful international partnerships. Awareness and proactive measures are key to protecting your business from scams and ensuring long-term success in the global marketplace.

FAQs

1. Why is it important to identify a Chinese company’s real business name?

Answer: Identifying a company’s real Chinese business name, rather than its English version, allows you to verify its registration with the Chinese government’s official records. This step confirms whether the company is a legally recognized entity, helping to protect against dealing with fake or unregistered companies.

2. What are suspicious contracting practices?

Answer: Suspicious contracting practices include a Chinese company suggesting signing an agreement with a different company, particularly one based outside of China. This can indicate possible fraudulent activity as it may be a tactic to sidestep liability and avoid legal consequences in China.

3. Why are official business stamps important in China?

Answer: In China, business stamps (also known as company seals or chops) have significant legal standing and are required on all official documents. If a Chinese company does not use its business stamp on agreements, it can be a significant warning sign of potential fraud. Verifying the stamp ensures that documents are legally binding under Chinese law.

4. How can I verify a Chinese company’s business license?

Answer: Every legitimate company in China must have a business license issued by the Chinese government. You can request a copy of the business license and verify its authenticity through third-party verification services. This step helps prevent dealing with unregistered or fly-by-night operations.

5. What should I investigate regarding a company’s capitalization and ownership structure?

Answer: Examine the company’s funding sources, overall financial health, and degree of leverage. Investigate potential conflicts of interest among company officials and shareholders. Check if the owners have other businesses and scrutinize litigation records. This helps identify patterns of unethical or illegal practices.

6. How can I check for irregular activities or operational issues?

Answer: Monitor for signs of financial problems or mismanagement. If a Chinese company is listed on the “irregular activities” or “operations canceled” list, it indicates involvement in activities that breach Chinese commercial laws or regulations. These lists are available on various Chinese government websites and through industry-specific regulatory bodies.

7. Why is it important to assess a company’s scope of operations and asset holdings?

Answer: Verify that the company’s offerings align with what they are officially sanctioned to do in China by checking their business license. Confirm that the company holds tangible assets and intellectual property, as significant holdings indicate stability and reduce the risk of fraudulent activities.

8. How does a company’s legal history indicate its reliability?

Answer: A history of legal disputes suggests potential management or operational issues and unreliable business practices. Verify involvement in intellectual property disputes, as this could imply a history of IP infringement. Understanding a company’s legal history helps avoid business scams involving repeated legal infractions.

9. What should I consider when evaluating a company’s supply chain and production capabilities?

Answer: Thoroughly evaluate their supply chain and production capabilities by visiting their facilities or hiring a third-party inspection service. Ensure the company can meet your production requirements in quality and quantity, and that their suppliers are legitimate and compliant with relevant regulations. This helps avoid scams involving misrepresented production capabilities.

10. How can I protect against bankruptcy risks in my contract?

Answer: Have a robust, China-specific contract outlining terms of the business relationship, including payment terms, delivery schedules, quality control measures, and provisions for financial distress or insolvency. Include an ‘advance payment bond’ to guarantee the return of your advance payment if the company fails to fulfill its obligations, protecting against business scams exploiting financial distress.

Contact us if you need help with drafting of contracts that follows Chinese laws and are enforceable in China, background investigation of Chinese companies, protecting patents, trademarks, verification of contracts to the law in China, or help with other legal challenges that you have in China.

If you require our assistance or have further questions about our services, please do not hesitate to contact our Customer Relationship Managers Jan Erik Christensen, at janerik@ncbhub.com . We look forward to hearing from you and helping your business succeed in China.

This article is provided for informational purposes only and is not intended to replace professional legal counsel. The information contained herein does not constitute legal advice and should not be relied upon as such. Reading this article does not establish an attorney-client relationship between the reader and the author or the author’s organization. Our website aim to provide general information for educational and communication purposes.