The threat of ending a business relationship might be the best leverage for a U.S. corporation in its dealings with a foreign company -- not litigation.
How American companies can protect themselves against defective products from overseas grabbed the headlines this summer when toy company Mattel (NYSE: MAT) had to recall more than 10 million Chinese-made toys for possible lead-paint and small-magnet hazards.
While the U.S. company can always sue a foreign company in an American courtroom, the damages from any judgment could be difficult to enforce abroad.
“Unless the (foreign) manufacturing company has a presence in the U.S., it’s going to do you no good,” said San Diego attorney John Schnurer, a principal with Fish & Richardson P.C. “It comes down to leverage … can they afford to lose you as a client?”
Schnurer is a patent litigator who has tried cases in China. He said the Chinese legal system is evolving and becoming more open, but lawsuits there are still politically influenced.
When commerce crosses borders, several laws can apply, said Nancy Kim, a professor of law at the California Western School of Law. The countries simply have to agree to one and put it in a contract.
The law of either country involved in the transaction can be used as can the Uniform Commercial Code or the Convention on Contracts for the International Sale of Goods (CCISG). The CCISG governs commercial transactions between companies who are from the country who are signatories to the convention.
“It depends on what the contract specifies,” said Kim, who teaches contracts, licensing and sales. “And the contract itself might specify remedies. It might say in an event that there is a breach or you don't meet specifications, then (you have to do) x, y and z.”
The law most frequently requested by American companies, not surprisingly, is U.S. law, including U.S. laws governing the interpretation of contracts.
“Most U.S. companies would like to deal with the body of law they're most familiar with,” Kim said.
In the contract, the U.S. company can also specify that the foreign business will provide indemnification in case of a lawsuit “or they can pull them into the litigation as well,” Kim said.
Not having a guaranteed legal remedy, however, is “a consequence of globalization,” Schnurer said.
“We are sovereign entities and each has laws that govern its society,” he added. “Not everybody has our jurisprudence.”
Schnurer said one of the best protections for an American company is to focus on its own quality assurance process, making sure the foreign company is preparing products with American standards.
“It comes down to the leverage you have as a company to define the requirements that you desire,” Schnurer said. “It’s more of a business issue. You're (asking) them, 'Can you make this product according to these specs?'" ”
Regulations and standards for product quality may be different in other countries, however. So while U.S. companies can't enforce American regulations on foreign companies, they can put provisions in the terms of a contract.
“As a particular matter, it might be difficult for Chinese companies to be aware of what all the latest (U.S.) regulations might be,” Kim said. “It’s up to the U.S. company to inform them.”
How well a product is selling in the United States can encourage both foreign and American companies to police themselves better.
Business has been affected by the Chinese toy recall, Kim said.
“You're already seeing a ripple effect in terms of consumers,” Kim said. “Now consumers are more conscious of where their toys are being manufactured. You have wooden, U.S.-made toys up front. Now consumers have placed a value on where the toys are made and not just price. Maybe They’re willing to pay more for a toy made in the U.S. or in Europe.”