A client called me and asked my advice regarding an uncomfortable situation.

One of his long-time suppliers, a manufacturer in Zhejiang, just announced they had gone bankrupt and had stopped all activity.

My client has wired a 30% deposit for an order that is currently finished, packed, inspected, and accepted for shipment. But that order is not leaving the factory’s warehouse.

The manufacturer’s contact person tells my client the situation is “difficult”.

What does the situation look like, exactly?

There is a list of creditors. The employees (who probably haven’t been paid for 2 or 3 months) are on top of that list.

Next come the suppliers, the bank, and so on.

Customers who have wired a deposit but aren’t getting their products are probably at the bottom of that list. Not to mention foreign customers who have no legally-enforceable contract drafted in Chinese…

I bet there are very few assets. If the boss owned the land and the building, he would probably have stopped the activity in another manner, to avoid losing everything related to his factory.

What to do in this situation?

First, call everyone you know who works for that supplier, and compare their versions of the story.

In case you can’t check the reality of the situation, you might want to contact a local lawyer who will try to approach the local administration and get some information. Or you might try to contact other companies in the area, who might have heard of the news.

If the factory is really bankrupt, consult the lawyer who drafted the contract you used for this purchase. If you didn’t do business with a contract, forget about this deal and move on…

Do NOT go to the factory. There are probably hundreds of disgruntled employees. They might force you to wire the remaining 70% of the order, and of course they won’t ship any product to you.

Your nice shipment is probably still in the warehouse, but will certainly be sold to wholesalers/retailers in China, or to another exporter. In that last case, the exporter may look at the company name on shipping marks and may try to contact you… That’s probably the best case scenario!

What are the lessons for careful importers?

Fortunately this type of accident doesn’t occur very often if your supply chain counts 5 or 10 or even 50 suppliers in China. But you should take a few steps to reduce your risks:

1. Try to evaluate the financial risk of your potential suppliers. To that end, you can pay for a background check and look at the supplier’s level of profit (or loss) and debt, as well as the trend of the top line (sales).

Keep in mind that the numbers are probably false. Most manufacturers have strategies to escape taxes. But here is a rule of thumb: if the numbers look good, they are probably better than reported; if they look bad, the situation might be worse than reported.

Note: if you work with a lawyer specializing in Chinese business, he can collect and interpret the data for you.

2. Make sure you cultivate several points of contact within your suppliers’ companies.

A Chinese salesperson sometimes quit, tells his customers that the factory has gone under, and directs them to his new employer/venture. You simply CAN’T trust what a single person tells you.

3. For large orders, it often makes sense to pay by letter of credit. I touched on this topic many times before on this blog. L/Cs are a grossly under-utilized tool.

Once again, for the record: a pre-production “deposit” is actually a down payment that will never be returned by the supplier.

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What do you think? Can you think of other tips to avoid this situation? Am I too pessimistic when I advise to just move on and forget about the deposit?