As more SMEs look to outsource their work to cut costs, experts agree that minding the legal and contractual details is paramount to success. They also recommend searching for alternatives to established practices.

"There are SMEs that are being denied loans in the United States," said David Dayton, CEO of Silk Road International, which acts as a representative for manufacturers who outsource to the mainland. "They couldn't get credit and need to look for options to minimise risks and costs, as well as try to see if they could get credit or financing at different places from a regular bank."

One of the seminar speakers at the January HKTDC Hong Kong Fashion Week for Fall/Winter 2010, Mr Dayton said, "you can minimise risks and costs by, for example, paying upfront and engaging auditing companies.

"SMEs are not doing a lot of auditing.They think it's a lot of hassle, but there's a lot of wasted money that can be saved or problems avoided if people are wise about the factories they choose."

He also suggested carrying out legal searches to determine if the supplier has outstanding debts. Another recommendation is deploying staff to oversee production so that "you don't have to do significant hiring if you have someone that knows the product or who can represent you.That will save weeks of delays and thousands of dollars of mistakes."

Financing Options

Seeking other means of financing is another way SMEs can save money, according to Mr Dayton.

"If you have some assets on the mainland, maybe you're a small company with an office here, the Chinese banking system for the last eight months has just been handing out loans to anybody that can prove they have assets," he said.

For an overseas SME that may not have assets on the mainland, the factory they are working with "might be able to tap into these loans.

"We're seeing people in fashion able to get credit for clients that have a good record, brand-name recognition," Mr Dayton said. "Even if the foreign buyer doesn't have assets, its supplier on the mainland may have access (to funding)."

He added added, however, that trust in foreign companies is "very low right now.

"More Chinese factories than ever have been stiffed for payments and had orders cancelled by foreign companies. We have been asked more than once about how a Chinese factory could do some due diligence on a potential foreign client," he said.

"Foreign companies are no longer seen to be the cash cow, the e-ticket, or the trusted legal/honest party in a business relationship. Now it is the Chinese factories that have serious and well-founded mistrust of foreigners and their willingness to honour legal agreements. You can no longer go into China with the attitude that ‘Hey, you should trust me, I'm from the developed country, I'm the one that doesn't trust you.' The roles have been reversed.  Maybe you have cash, and that's certainly a negotiating plus, but you no longer have the moral high ground of ‘my system is better than yours.'"

Legal Sourcing

Many manufacturers previously believed that it was always better to have a contract based on a legal system outside the mainland. That is changing in some respects, according to Hong Kong lawyers Richard Keady and Andrea Sangiorgi of the international law firm, Barlow Lyde & Gilbert.

When disputes arise, according to Mr Keady, "often, it's better to have a contract based on PRC law.

"If there is some issue with intellectual property, it can be better to deal with these in China directly. Arbitration in China is also not a bad idea. As soon as the award is issued, it is easier to enforce," he said.

Mr Keady added, however, that the quality of the legal system "does vary from place to place. The court system in Shanghai will be better than in Chengdu," he said. "In the interior, it is a different matter. Even close to Shanghai, courts can be subject to manipulation."

Supply Chain Protection

Product liability is another area of concern for foreign manufacturers and importers, especially given the recent history of tainted products coming from the mainland. In some cases, Mr Keady said, "the whole supply chain could be liable, including the manufacturer, the assembler, the retailer, the wholesaler - it could be all of those companies. It depends on the law of the nation bringing suit. The injured person will, of course, go to the person with the deepest pockets. It's important for all the companies along the supply chain to make sure they are protected. And as a practical matter, it's important they get their quality control right."

Mr Keady said to protect against liability, it was also crucial for manufacturers, importers and others in the supply chain to secure an indemnity from their suppliers. He cited one client that is having some measure of success getting personal guarantees from the factory owner included in the contracts.

"While it doesn't fit every circumstance, it is an interesting approach," Mr Keady said, and one which gives new meaning to the old saying "my word is my bond."

Mr Keady added that when a company does run into problems on the mainland, there are two options: either go to court, or use government bodies to remedy the situation.

"Using the ministry route, they (authorities) can't award compensation," Mr Keady said, "but they can levy fines and seize goods and equipment."

The lawyers, like Mr Dayton, also said SMEs should follow some common-sense guidelines in their work on the mainland.

"Register your rights as soon as possible," Mr Keady said.

Follow the "golden rule and put it in writing," added Mr Sangiorgi. "Whatever it is, whether it's a long-term relationship, get it in writing."