Prof. Patrick O. Connelly: China and the West – Credit Risk Management from a Contrasting Frame of Reference

Trade among China and the many Western enterprises is accelerating despite and perhaps, as a result of global market volatility. As a consequence, mutual counterparty understanding should enable them to enjoy a safer, less risk-laden and higher potential trading experience.


For trade credit risk professionals in any venue where the local legal system and version of the rule of law differs from their national process, this article is presented in two parts. It will provide a counter-perspective, a different view through which to identify potential or actual risk and apply risk management strategies in order to promote maximum profitable trade.


In this article, Part I, the author discusses a process to be followed regardless of the venue of the buyer or seller. The core of the trading partner relationship is the written agreement, properly completed and memorialized according the required practices of the local venue.


Under special circumstances, where a transaction is intended to be shariah- compliant, an additional review will absolutely be required in order to assure that the underlying transaction not only complies with Western partner legal guidelines, but firmly complies with shariah requirements to assure for both parties a satisfactory outcome.1


Any transaction should begin with a written agreement between trading partners. Trading with partners in foreign markets requires a serious due diligence. Though experience is the best teacher in these cases, having preliminary insight helps. Begin by understanding the performance history of a potential trading partner. This greatly reduces the risk of a delay or outright default in satisfying mutually agreed terms and conditions.


Note at the very beginning of the transaction what protection is prudent to incorporate into the sales agreement, and what additional protection should be invoked in order to mitigate risk of default in the transaction. Ignore these recommendations at your peril. The author reminds the reader that though the sale is booked as the goods leave the seller’s dock, risk is introduced at many points in the transaction process and once attached remains a permanent part of the transaction.


It is recommended to follow these steps to assess and limit risk:


  1. Always memorialize the transaction in writing
  2. Anticipate the most common areas of conflict – and proactively address each area
    1. Interest clause
    2. Attorney fee clause
    3. Choice of law
    4. Waiver of claims for nonconforming goods


A. Key Risk Management Success Factor – the Written Agreement

A continuing issue, growing as foreign trading partner transactions expand, is that of consummating a transaction with payment according to terms. In this time of challenging fiscal conditions and global market and economic volatility, it is even more difficult to convert invoices to cash within terms. What is to be done?


Initially, it is critical that the written agreement identify the transaction anticipated by both parties, buyer and seller, AND represent an enforceable transaction at law. This requires both legal and operational experience, both of which are generally available in every market.


In the case of the transaction anticipated by this article, a sale by a Chinese company to an American enterprise; it needs noting that China has exercised its rights under Article 96 of the U.N.(CISG) requiring that all contracts governed by the CISG be in writing to be enforceable. This means that a dispute between parties to the written agreement will be governed by the rules of the CISG2.


In addition, for domestic U.S. transactions, contracts for the sale of goods with a value of USD 500 or more must be in writing to be enforceable. Regardless of choice of law, oral contracts for the sale of goods to a U.S. buyer will be difficult, if possible to enforce.

Though this is a specific country law reference, it provides guidance to the fact that ALL transactions should be memorialized in writing.


The transaction begins by defining what the counterparties intend by the transaction. This act creates the objective to trade. The contract is intended to define rights and duties of each, and the limit or establish penalties attaching for failure to perform under the agreement.


B. Some of the considerations of an economically efficient agreement


    1. Default interest clause

      Introduces an  legally enforceable penalty fee, to be imposed to cover seller carrying cost of goods involved in the agreement. Properly established, this fee becomes chargeable on the date established by the agreement and in an amount agreed upon between the parties. The amount of the fee is dependent upon several things. First, parties may contractually agree to a default fee percentage. That determines a value for mutual performance in a timely manner.Additionally, where CISG applies, seller without such a clause may be precluded by U.S. courts from recovering ANY default interest from the buyer.Where CISG does not apply, the amount of interest that a seller may charge, given no contractual default interest clause, falls to state law, and varies from state to state.
      Without the protection of a contract default interest clause, counsel informs that some U.S. states set pre-judgment interest rates ( rates allowed on amounts owed before courts award a judgment), as low as 6% per annum. Some post-judgment rates are as low as 0.28% per annum. Operationally, such low rates discourage speedy repayment of the debt once the judgment has been rendered further increasing seller cost and complicating closure of the transaction.Regarding an allowable interest rate, note that fixing a default interest rate by agreement of the parties is allowable under U.S. law. However, the interest clause must be specific and also in writing, preferably as a contract term. U.S. federal courts may place a cap on the post-judgment interest rate, holding it to the statutory rate ( currently .028% per annum) unless:

      1. Contract expressly states a different post-judgment rate will apply
      2. Plaintiff asks for the contractual post-judgment rate in its pleading, and/or
      3. Plaintiff requests the contractual post-judgment rate in the pre-trial order

      This highlights the merit of having both corporate policy and operating procedures that integrate this requirement into the official corporate sales agreement. It also introduces risk management oversight into these preconditions, a corporate responsibility.

      Given the above, an enterprise may negotiate an interest clause that identifies both pre-judgment and post-judgment default interest rate, usually in the range of 1-2% per month.
      In the event of actual default, these terms may facilitate a faster resolution to the dispute.

      A risk may be identified if the buyer objects to this rate structure. Consider that consider the reasons, and expect that either a delay is anticipated by the buyer, or the candidate buyer is simply not a viable sales candidate without additional protection for the seller.

    2. Attorney fee clause

      Important if foreign parties are suing in U.S. courts. This provision of the agreement specifies that the prevailing party in litigation to enforce a contract, is entitled to recover cost and fees, including attorney fees from the losing party. The importance arises from an  “American rule”, whereby litigants in the United States normally pay their own fees and costs regardless of the outcome of the case.

      Litigants will not only pay their attorneys, but cover costly expenses including taking depositions, engaging and presenting expert witnesses etc. This adds considerable cost to litigation. litigation. The American Rule may be overridden by the inclusion in the agreement of the Attorney Fee clause.

    3. Choice of Law

      The decision of which law will govern is also critical in that it fixes the law that will govern in the event of dispute arising out of the contract.

      Absent this clause, the facts and circumstances surrounding a case, may delay both a resolution and a decision favorable to the seller. In fact, the default jurisdiction may present laws that in themselves are unfavorable to the seller. Include the clause in your agreements.

      Learned counsel recommends that buyer-seller agreements between foreign  and U.S. parties should strongly consider New York state law and specified governing law.

      Benefits to the foreign seller include:

      A. Greater acceptance by the buyer since they will want U.S. choice of law, excluding the CISG
      B. Reducing the complexity and cost of seller’s counsel in the U.S. since most members of the U.S. bar are unfamiliar with the CISG
      C. Increasing the probability of unexpected or unpleasant conclusions reached by the court with regards to the application of the CISG, since most U.S. courts are less familiar with the CISG treaty.
      D. Reduced volatility in the process translates to both lower overall cost and risk as well as more time to focus on the business

    4. Waiver of Claims for Nonconforming Goods Clause

      Risk increases wherever there is an unspecified time frame and uncertainty of outcome.By including this clause, the buyer relinquishes, at the end of a specified period of time, his right to assert a claim and pursue remedy for seller’s failure to supply goods that comply with the requirements of the contract. The spirit of this clause is less to limit seller interest in providing a high quality product, than to encourage a buyer to examine the goods in a timely manner. Such examination avoids confusion introduced when different laws are applied.

      Un the CISG, buyer must examine the goods as soon as is practicable, and all remedies relative to the failure of goods to conform to the specifications indicated in the contract shall be barred if the buyer does not notify the seller of the claimed, or alleged nonconformity:

      • Within a reasonable time after it has or should have discovered the nonconformity, or
      • Two years from the handing over of the goods.


      The rules stated above in fact create more uncertainty and confusion, for example:

      • When examination was practicable?
      • When the buyer should have discovered a lack of conformity?
      • What constitutes a reasonable time between the discovery of a lack of conformity and notice of same to seller.


      Related problems present themselves when dealing with U.S. laws as well.

      In order to avoid the confusion stated above, foreign sellers and U.S. buyers may agree to  include terminology in the agreement that fixes a specified point in time beyond which the buyer will be barred from rejecting the goods or asserting a claim for defects or deficiencies; so long as the agreement provides buyer with reasonable time within which to discover any defects.


Trade credit risk management remains a critical success factor in maximizing profitable trade. This first part identifies necessary features of importance in efficiently establishing and developing a customer portfolio which supports that objective.

This document is proprietary to Professor Patrick O. Connelly and the Tao Institute for credit and Risk Management, and must not be copied without express permission of the author. Please direct inquiries to: Professor Patrick Connelly, CEO, Tao Institute for Credit and Risk Management, Clearwater, Florida, USA.
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