The voracity of growth in the Chinese economy in the past few years seems to be coming to an end. The implications of this are widespread and are having a direct impact on businesses in the UK, particularly those which source and import goods from China. Here we look at the consequences of this downturn and how UK businesses can best manage their contractual relationships with China.

The situation in China

China has not escaped the effects of the global economic downturn. Even before the events in the banking world in the past few weeks, many businesses in China were struggling to survive financially. This is due to the combined effect of several adverse economic and political factors. Chinese businesses are struggling to cope with a spiralling rate of inflation and dealing with the implications of new contract labour laws that came into force early this year. These laws were intended to give Chinese employees new rights as against their employers. Whilst employees have roundly welcomed the changes, from the employers’ perspective it is a different story. The increased regulation of employment relationships and greater employee rights has meant increased overheads, which are eating into turnover.

Effects on Chinese businesses

China has traditionally been a source of low cost goods for businesses in the UK. Going forward, it is likely that many Chinese businesses will have little choice but to substantially increase their prices in an attempt to offset the increased costs they are facing. It is also possible that many businesses which are unable to meet these increased cost demands will simply go out of business altogether. To illustrate the scale of the problem, the Federation of Hong Kong Industries has recently estimated that around 10,000 factories in the Pearl River Delta region of the country will scale back operations or close down altogether by the end of 2008.

Implications for UK businesses

This is obviously bad news for those UK businesses that currently source some or all of their manufacturing components or other goods cheaply from Chinese suppliers. In the coming months, they are themselves likely to face increased ‘knock-on’ costs or a complete failure of supply. Bottom line profit will be hit and businesses without a reliable supplier will not be in a position to fulfil contractual obligations to customers. For businesses faced with a deepening economic crisis in the UK, this news is likely to be the last thing they want to hear. However, there are positive steps that can be taken to manage and minimise the commercial impact of the situation in China.

What UK businesses should do

Initially, businesses should contact their existing supplier and find out directly from them how they are likely to be affected. Are future supply problems anticipated? If so, can workable solutions be found? If there is a formal contract it may need to be amended to reflect any agreement reached.

Businesses with two or more suppliers in China may consider beginning to source from just one supplier that is able to demonstrate its financial stability. If there is a formal contract with the ‘risky’ supplier, it should be reviewed to identify possible grounds for termination. A business that terminates a contract without proper grounds for doing so may well find itself in breach of contract (and liable to pay damages as a result), but another option is to find a completely new and reliable supplier in China (or indeed in another country altogether). In this case, a new formal contract should be put in place. It should contain all the relevant clauses to be as commercially robust as possible and ensure future continuity and quality of supply.

If a UK business is wholly dependent upon the existence of one supplier and switching supplier is not, for any reason, a realistic option could equity investment by the business in that supplier or a joint venture arrangement be worth exploring?

Conclusion

Businesses should carefully review their relationships (including any contracts) with Chinese suppliers and consider whether any of these options could assist or stabilise a crumbling relationship. What is right for one business may not work for another. Businesses should work closely with their legal advisors throughout the process. The contractual issues will be key and may be decisive in whether a UK business is able to weather this particular financial storm.