2023.01.18 ZHOU, Feng (Frank)、CAO, Xiang (Shawn)、Zhilian Huang、Wenhan Cao
China has never officially closed its doors, but cumbersome restrictive measures during the pandemic led to a virtual standstill in the country’s exchanges with other nations. Since November 2022, China had gradually optimized its COVID strategies and lifted most of its quarantine and travel restrictions domestically. From January 8, 2023, China's exit-entry policy has also been greatly loosened. The country is now prepared to embrace the world once again.
At the time of China’s re-opening, the world has seen profound changes. Inflation, energy crisis and climate change continue to trouble many countries, while concerns over economic recession and security dampen the confidence of the market. In the face of a complex and uncertain “new normal” after the "re-opening", is China still a market worthy of investment?
China remains a promising market for most foreign investors in a post-covid world. China remains one of the most friendly nations for foreign investment and foreign capital. As Premier Li Keqiang said: "China will not reverse its open door policy, just as the Yangtze and Yellow Rivers will not reverse their courses". China's huge domestic market, robust supply chain, sound infrastructure, as well as its highly qualified, hard-working and loyal labor force can bring decent returns for foreign investors. To remain competitive in the Chinese market, however, foreign companies and investors must be more active than ever to monitor local regulatory and market changes, and be more agile in their strategies and operations.
Taking advantage of its more than 30 years of experience in assisting foreign clients, JunHe prepared this series title "Doing Business in a Re-opened China" to summarize in Q&A form the most common questions foreign investors have regarding investing and doing business in China. We have also designed novel legal service products to address client needs. With these efforts, we are hopeful that foreign investors and companies can steer clear of hidden rocks in China, build more confidence, and remain competitive and prosperous in this important market.
Episode I: Toes in Water
Chapter I - How to Conduct Due Diligence on Chinese Suppliers
Foreign companies and foreign-invested companies need law-complying and reputable business partners in China. It is important to conduct due diligence on their Chinese suppliers. In this chapter, we answer some of the most frequently asked questions from our clients regarding due diligence on Chinese suppliers.
1. Is it common to conduct due diligence on suppliers in China ?
Due diligence on suppliers in China is very common. Foreign companies, foreign-invested companies, as well as domestic state-owned and privately-owned companies in China all conduct due diligence on potential business partners due to commercial considerations or internal requirements.
2. What are the focuses during supplier due diligence?
The focuses of supplier due diligence depend on the purposes of the investigation. Many investigating parties are particularly interested in the legal compliance of Chinese suppliers, especially anti-corruption compliance, so the focus is often on the current and historical compliance of the suppliers, including any record of administrative penalties or litigation involving the suppliers and their executives, shareholders, and actual controllers. Questions are frequently asked if they have engaged in commercial bribery or other misconduct, and whether they are affiliated with the employees or management of the investigating party. In some other investigations, the investigating party will focus more on the supplier's background and credentials, such as the supplier's shareholding structure, beneficial owner, financial statements, solvency, business situation and market reputation.
In recent years, some clients have been asking more questions out of export control and sustainability considerations. Suppliers' raw material origins, labor rights protection, corporate governance and environmental compliance have become increasingly interested by our clients.
3. How is supplier due diligence normally conducted in China?
Due diligence on suppliers can be conducted either "back-to-back", where suppliers are not informed, or "forthright" where suppliers are asked to provide needed information, or a combination of both. The "back-to-back" approach typically relies on public sources, while the "forthright" approach typically requires suppliers to fill out questionnaires, submit materials and attend interviews. Due diligence can be conducted through online and offline searches and interviews, and review of materials provided by suppliers. It is also common to cross-check the findings through on-site visits and third-party interviews for important matters. In terms of the scope of the due diligence, the investigation often needs to cover the supplier's affiliates and beneficial owners in addition to the supplier itself, but it is less common to extend the investigation to the supplier's upstream and downstream partners.
A "forthright" due diligence typically takes around 2-4 weeks, if the supplier is cooperative in the process. The "back-to-back" due diligence usually takes less time.
4. What public information is available on the supplier?
In China, an investigating party can access a huge amount of valuable public information regarding its partners in China through various sources. Most frequently used sources include the following:
5. What information is not publicly available?
For non-public companies, unless they choose to voluntarily disclose to the public, their financial information (including management accounts, audit reports, books and records, etc.), internal resolution documents and business transaction information are generally trade secrets and not publicly available. Public companies have more public information due to disclosure requirements. If the address of a company’s real estate is available, we can run public search on the ownership and mortgage status of the real property. However, it is usually not possible to search the real property owned by a company if we only know the company name. Similarly, it is difficult to search other assets and liabilities of a private company through public sources. Certain non-public information, such as historical documents filed by a company to a registration authority, can be searched by a qualified attorney.
6. Is it possible to obtain non-public information through investigation companies?
There are cases where an investigating party hires an investigation company or even a private detective to investigate the background of a supplier. However, most clients are very cautious about this approach. The main concern is that it might be difficult to ensure that the investigation company conducts the investigation in compliance with the law. If the investigation company infringes the trade secrets or privacy of a third party in the process, the client could be held liable.
7. Is it necessary to investigate a supplier's affiliates and beneficial owners?
In supplier due diligence in China, investigation is usually not limited to the supplier itself, but to its affiliates and beneficial owners. This is because: (1) in practice, a supplier may leverage different entities during the negotiation, signing and performance of the contract with the client, and such entities are generally controlled by the same ultimate owner but with different shareholders, assets, liabilities, operations, and personnel; and (2) the reputation, debts and operations of a supplier may depend significantly on the status of its parent/affiliated company and beneficial owner, thus the failure of a beneficial owner may also negatively affect the supplier. Therefore, most supplier due diligence in China will extend to the supplier's affiliates and beneficial owners.
8. What are the issues commonly identified in supplier due diligence?
The following issues are frequently identified in suppliers due diligence: the supplier and the executive of the investigating party are related parties (for example, an executive may take advantage of his/her position to direct the company to procure goods or services from a supplier directly controlled by him/her or his/her relatives, and consequently jeopardize the interests of the company); the supplier or its core members have been subject to criminal or administrative liability due to regulatory compliance issues or fraudulent actions; the supplier lacks operation permits or other necessary qualifications; or the supplier is involved in material disputes. The early detection of such issues allows the client to avoid misjudgments and take precautionary measures in advance (e.g., requiring the supplier to give a performance guarantee).
9. What are the main challenges in supplier due diligence?
The challenges include language and cultural barriers in communication, lack of access to the requested information, inability to determine the truthfulness and completeness of information, and challenges in assessing the risks at practical level. Counsel from an experienced professional advisor will be particularly important in such process.
10. What can outside counsels offer in supplier due diligence in China?
Outside counsels with international vision and local wisdom can add great value in the supplier due diligence. A team of local attorneys proficient in English and versed in local law and practice can help clients to request information and identify issues more cost-effectively.
JunHe offers both standard and tailor made due diligence menus for our clients. Please email us at China_Business_Support@junhe.com to inquire more about our fee quote and credentials for different exercises.
In our next chapter, we will discuss “How to set up a business operation in China”, stay tuned.
1. China and Chinese suppliers as described in this chapter should be interpreted respectively as Chinese mainland and suppliers in Chinese mainland. Chinese mainland, Hong Kong, Macau and Taiwan are subject to different jurisdictions. The discussion in this chapter applies only to Chinese mainland