It is one of the worst things that can happen to a company: the goods have been delivered, the work has been done, and yet the payment due is not forthcoming. The debtor might go incognito, becoming unreachable by phone and unresponsive to e-mails and faxes. Or he might continue to give a series of promises to pay up that are never fulfilled. Deadbeat companies can be a problem everywhere, but in China they are exceedingly common, and an easy trap to fall into.

"Of course it happens, and there's very little that we can do about it," says the sales manager of a Shanghai-based marketing company, who understandably says he feels a little helpless when customers fail to pay up. "Sometimes we just put it down to experience. Once when we didn't get paid, we kept on sending one of our sales team to [the clients'] office until he became a nuisance, and only then did they start to talk to us about giving us some money."

The effects of companies' persistent failure to pay their bills are twofold. First, there are the obvious effects on the financial health of the seller. Second, it creates an atmosphere of distrust, where reliable companies become subject to a level of scrutiny that they do not deserve.

Not getting paid poses a greater risk for different kinds of companies. "All companies are susceptible," says Jay Hoenig, China president of risk management company Hill & Associates. A significant proportion of Hoenig's business is performing checks on local companies for foreign companies entering China. "It's a lot easier when you have a hard product to deal on a cash-on-delivery basis. When people are supplying services, there's more room for performance disputes."

Xizhen Wang is the senior commercial manager in China of Atradius, a company that sells insurance designed to help protect companies from bad debts. She suggests another factor that can affect how vulnerable a company is to unpaid credit. "What is important is whether the seller is operating in a buyer's market or a seller's market. The more replaceable a company's product is, the more likely there is to be a problem. But if the buyer's business is reliant on the product that they're buying, such as with raw materials, they're more likely to pay on time."

Failing to manage the money

There is no single reason for the problem, but rather a myriad of different factors that combine to create a multifaceted whole.

Perhaps the biggest problem is inefficiency. "It's not that the buyer does not want to pay, but they just don't have an efficient internal control system that can process the payment quickly. This is why many companies have started to set up separate credit management departments that make an efficient connection between the sales people and the financial people within the company," says Wang.

The tight cash-flows that Chinese companies operate under contribute to the phenomenon known as triangular debt, when a buyer is unable to pay the seller because he is allegedly waiting to receive money from a third party, which in turn might be waiting for payments from other parties and so on. And, though issues concerning inefficiency and the misjudgement of cash flow are the most common cause of companies not paying up, it also sometimes happens simply because of dishonesty: some companies are best left alone.

Another problem is trade disputes: it is common for a buyer of a service to refuse to pay the agreed price upon the completion of the work because it fails to meet their expectations. It is then down to the seller to reassert the original price, not the new one being offered by the buyer.

Given the risks, it is wise to put as many safeguards in place to avoid the possibility. Luckily, the way a company can protect itself in China involves employing the same common sense as is required anywhere else in the world; the only difference is that an oversight when performing due diligence in China is potentially more likely to cause a loss for the company.

Know thy client

"If you're going to enter into an agreement with a Chinese company, you've got to know who you're dealing with," advises Hoenig. This is problematic in China, he says, because plenty of information about a company that would be public in Europe and America need not be disclosed by a Chinese company.

It is not uncommon for a Chinese company to keep different sets of accounts to show to different people - one for the government, one for the customer, one for internal records and so on. Practices like this underscore the importance of performing formal and rigorous due diligence on a company's reputation before doing business with it. It is essential to find out whether or not they have a reputation for paying on time, whether or not they are licensed to do whatever they say they do, and whether the size of the company is in proportion to the size of the order.

"Make sure that you have a contract document that clearly specifies payment terms and conditions," says Hoenig. "How much? When? To which bank? This needs to be articulated before you begin the work or supply the goods." It is also important to make sure that the person who represents the buyer is authorised to sign the contract and make the claims on behalf of his company. Finally, he says, it is essential to remain cash positive - get a cash deposit or a letter of credit in advance. All of this might sound straightforward, but in the enthusiasm to reap profits from China, many companies overlook taking simple precautions that they would take at home. "Many US companies do more due diligence when they move from Florida to Ohio than they do from Florida to China," says Hoenig.

Another way in which a company can protect itself from losing out to people who do not pay is by taking out credit insurance, a product that has existed in Europe for some time but is very new in China. Credit insurance does not quite work in the expected way, however: it is not as simple as paying a premium and receiving money from the insurer if a buyer fails to pay. "Its added value is risk prevention," says Wang. "With credit insurance, during the period of the policy, the company and the insurer are constantly in mutual communication, working together to prevent the risk that is created by the buyer."

For each buyer the seller has, the insurer places a limit on how much they will give the policy holder if they fail to pay. The insurer decides on this limit by performing its own reputation checks on the buyers. Even in a situation where the insurer pays up when a buyer has failed to pay the seller, the policy holder is still obliged to do their best to reclaim the money, which, if received, is split between the seller and the insurer.

Insuring against the worst outcome

Credit insurance, by carrying out checks on potential buyers, encourages choosing reliable companies, thus preventing payment issues before they become a problem. This appears a sensible route to go down because the last resort is to try to take some sort of legal action against the debtor, and in China, this can be a difficult process.

For a start, debt collection companies are banned in China, so companies have to go through the often arduous and expensive process of getting lawyers to make demands on their behalf - though for some companies all it takes to get clients to cough up some money is a couple of letters from a lawyer. But if that is unsuccessful, then arbitration is the next logical option, and, failing that, litigation.

The problem with taking another company to court in China is that even if a ruling is made in the plaintiff's favour, getting that judgement enforced can be easier said than done. A judgement that is made on a national level might not be enforced in the area where the guilty company exists. Although the Chinese legal system is evolving, going to court is an expensive process that can, and often does, turn out to be a waste of time. When it comes to balancing the accounts and avoiding bad debtors, an ounce of prevention through safeguards is easily worth a pound of legal cure.