March/April 2009
In the aftermath of last fall's economic collapse and the ensuing trade problems, scrap sellers are seeking new measures to protect themselves in agreements with foreign buyers.
By Ann C. Logue
From record highs to dramatic lows, 2008 was a doozy for the scrap industry. The economic meltdown that began in the mortgage market expanded to the entire global financial system. The credit crisis and worsening recession slowed down consumer demand for goods just as China went into a post-Olympics purchasing slump. Together, these factors drove down the value of almost everything, scrap commodities included. "I had never seen the volatility that we experienced in the third quarter and into the fourth quarter" of 2008, says Bob Garino, ReMA's director of commodities, who was surprised by both the sharpness and the speed of the price declines. One of the few items to rise in value—the U.S. dollar—even worked against the industry, making scrap exports more expensive for foreign buyers.
Scrap buyers facing reduced demand for their products, higher costs, and vanishing credit found themselves in a bind, without money to pay for material they had purchased. "Companies do have financial problems because they operate with very tight budgets," says Tony Huang, chairman and CEO of Sigma Group, an aluminum smelter and scrap trader based in Shanghai. Buyers sometimes defaulted on contracts or tried to renegotiate prices for scrap they had purchased but not received. If a company is fighting for survival in a recessionary economy, Garino points out, price reductions may seem like a reasonable request.
Other companies, however—ones that were not in financial trouble—saw falling scrap prices as an opportunity, Huang says. "They figure that if other companies are renegotiating, then it is all right." These importers canceled orders while scrap was on the water, demanded deep discounts before they would accept delivery, or left materials on the docks rather than complete the transaction. Further, sellers say, buyers have trumped up quality claims as a way to get out of a purchase.
Scrap sellers have cried foul at these actions: These buyers were not interested in renegotiating their purchases when scrap prices were rising, they say. Some sellers issued ominous warnings about how such behaviors will affect long-term business relationships; others appealed to governments and ReMA and the Bureau of International Recycling (Brussels) for help. Still others are looking ahead: At some point, credit will ease, prices and demand will rise, and the international trade in scrap will grow again. When that happens, scrap sellers want to proceed with caution to avoid a repeat of last fall's events. They're looking for strategies to ensure payment and to pursue buyers who are in breach of contract. Some strategies are useful in any international transaction, others are specific to the country that has been the target of the most ire: China.
Collection Strategies
The simplest way to ensure payment in a scrap sale is to get the payment in advance, experienced traders say. Tom Mele, president of Connecticut Metal Industries (Ansonia, Conn.), says he has been burned by a few customers, thus his firm now requires cash up front from almost all buyers in China and South Korea. "We won't even load the container until we have a check in the bank," he says. That way, he doesn't have to worry about customers performing. The downside is that not all customers have the liquidity to pay for a metal shipment in advance of delivery. No shipper wants to make life easy for bad customers, but some of the buyers caught in this mess are good ones.
Alter Trading Corp. (St. Louis) has taken a variety of steps to respond to contract breaches and protect future sales, says Robert Stein, the company's vice president of nonferrous marketing. It is demanding larger deposits from some customers, it has cut off trade with others, and it's starting legal action against others.
Banks offer some services that can help protect companies in international transactions, but they are not always cost-effective. A bank letter of credit, in which a bank guarantees payment on behalf of its customer, relies on the credit of the buyer's bank rather than the credit of the buyer itself. (With a few notable exceptions, most banks have better credit ratings than their customers.) Demanding a letter of credit from a buyer can be a form of due diligence: The bank won't issue one if it's not certain the buyer can pay. The letter of credit is useless, however, if the buyer rejects the shipment due to a quality claim—an issue that has bedeviled many scrap shippers in recent months. Insurance companies and the Export-Import Bank of the United States offer credit insurance to exporters, but it applies only in the event of the buyer's bankruptcy or certain events in the destination country, such as war or a currency collapse. If a customer is able to pay but chooses not to, neither a letter of credit nor credit insurance will help.
Nor can companies turn to their government for help. Disputes between specific companies are contractual problems, so the remedies must come from contract law. In other words, the seller must sue, most likely in the court of the destination country or another country in which the buyer has assets. Governments and international bodies such as the World Trade Organization have no ability to intervene in disputes between companies. A WTO-level trade dispute is one in which a member country allegedly has imposed tariffs or regulations that affect the ability of foreign companies to compete in that country. None of the actions reported so far rise to that level.
Culture and Contracts in China
ReMA's Bob Garino, who has heard from a wide array of ReMA members facing trade difficulties, points out that "it's not just the Chinese" who are renegotiating or reneging on contracts. "We've seen examples of this in the United States and Europe." Stein concurs. "It isn't just China, and it isn't the whole country," he says. "It's a significant number of companies in China and elsewhere." Many of Alter Trading's Chinese customers have behaved honorably and paid as invoiced, Stein says, and some asked for renegotiations because of bona fide financial issues.
That said, other Chinese companies renegotiated because they could. Chinese buyers know they are in a position to bargain, Huang says. "Most of the smelters still have inventory to use up. They see an opening, and they take it."
Stein is concerned that renegotiation might become a habit rather than a one-time response to an unusual market, but those concerns are not keeping Alter out of China. Indeed, it's hard to imagine today's scrap industry without China, which in the past decade has become the destination for much of the world's scrap. In 2007, for example, China bought 55 percent of U.S. aluminum scrap exports, 68 percent of U.S. copper scrap exports, and 76 percent of U.S. recovered fiber exports. China's growth as a scrap consumer had been so rapid, robust, and recent that the decline has shocked both buyers and sellers.
Some Chinese companies are reputable, Huang says, but sellers haven't always taken the time to figure out which ones are and are not. Some scrap sellers may have loosened their business practices a bit when prices were going up, Garino says, and not exercised the due diligence they should have. "This has been a sobering lesson for a lot of people." Now that many deals have gone sour, the seemingly opaque business environment in China is further complicating companies' attempts to find redress for their grievances.
The U.S. and Chinese business cultures are actually more similar than most people think, says Dan Harris, a partner at Harris & Moure (Seattle), a law firm with personnel in China, and keeper of www.chinalawblog.com. A lack of interest in forward pricing or in strong contracts is not based in the Chinese culture, he says. "There are some very good businesspeople in China. There are some very poor businesspeople in China. It doesn't take a great businessperson to understand the forward market. … A lot of times, what is ascribed to culture is just circumstances." Harris gives the example of a Chinese buyer with cash flow problems who pays its local suppliers before foreign ones. Most U.S. companies would do the same thing, he says—not out of patriotism, but because the local company can cause trouble much more quickly than an overseas one.
Some Chinese companies do use language and cultural differences to deceive, Harris says, thus due diligence is essential. In one scam, a company assumes the identity of another company, one that has a long history and good reputation. He once worked with a toy company that thought it was purchasing from a major Chinese manufacturer. Representatives of the U.S. company even had meetings at the manufacturer's offices and toured the factory. In reality, the toy company was working with an independent broker who was presumably slipping someone at the plant bribes in exchange for tours and meeting space—and who disappeared as soon as the dispute arose. The major manufacturer knew nothing of the deal.
Companies doing business in China should ask for proof that they are dealing with the right parties. "Ask to see the documents," Harris says, and do not fall for the line that "that's not how we do business here." A reputable firm will work to bridge cultural differences, while a bad actor might hide behind them, he says.
Many scrap dealers have the impression that it's impossible for a non-Chinese company to sue and win in China. That's wrong, Harris says. The Chinese do recognize contracts, he says, but they have to be solid contracts, preferably written in Chinese, and calling for resolution in a Chinese court. Other types of contracts, including those implied by a paper trail, can be useless in the Chinese legal system. Harris has what he calls his bike-lock theory of Chinese law: "If there are 30 bikes, and one of them has a really good lock, it's not going to be stolen." Likewise, a seller that has a good contract in place is more likely to get paid, even if that contract is never tested in court. A contract is not a panacea, Harris says, "but you're dead without it." In fact, his firm will not take on a dispute in China unless there's a good-quality written contract in place.
Companies with a Chinese contract that sue in a Chinese court will find the litigation process different from that in the West. First, Harris says, a suit is not a negotiating tool. In the United States, a plaintiff might file a suit to force a settlement without a trial. In China, more than 90 percent of suits filed end up in front of a judge. It's easy to sue, he says, and cases move quickly. But judges tend to look at the fairness of a contract more than its legal language. Chinese judges do not like to see one party take all of the hit, Harris says, so suing for $1 million for scrap that is now worth $500,000 probably won't lead to a $1 million verdict, no matter what the terms of the contract were. That's not a bias against a U.S. company, he says—a Chinese seller would face the same judgment.
Without a contract enforceable in a Chinese court, the seller must look elsewhere to resolve a contract dispute with a Chinese company. The seller might have the option to pursue assets in Hong Kong or in another country, where the courts might be more likely to recognize e-mail messages, telephone records, and invoices as implied contracts, as they might in the United States.
Huang says Sigma Group enjoys some advantages in the scrap market because he has honored his contracts. "We get a discount compared with our competitors," he says, and he expects to be in a better position when the market turns. He is concerned, however, that competitors who are backing out of agreed-to terms are destroying the reputation of all Chinese scrap buyers. Randy Goodman, director of international sales and logistics at OmniSource Southeast (Spartanburg, S.C.), has long done business in China, and he admits to feeling frustrated by the payment situation there today. Some customers asking to renegotiate prices still want to be long-term customers, he says, and that may not be possible.
Moving Forward
Though it's little comfort to companies who've lost hundreds of thousands of dollars in bad scrap deals, last year's economic crisis is changing the industry in ways that might make trade problems less likely. A weak industry with excess capacity in down times almost inevitably faces consolidation. Sure enough, in December some of the largest Chinese steel companies announced they were merging. Tangshan Iron & Steel Co., Chengde Xinxin Vanadium & Titanium Co., and Handan Iron & Steel Co. merged with the encouragement of the Chinese government, which wants industrial companies to be more efficient. The new company will be one of the largest steelmakers in China. Bigger companies are formidable negotiators, but they also want to maintain supplier relationships. The smaller, weaker buyers that were unable or unwilling to pay for materials they ordered will suffer in comparison.
The consolidation trend among North American scrap companies—with each other and with steel mills—also could make a difference. Smaller companies might rely on personal relationships, but a larger corporation will have a corporate treasury department that does in-depth assessments of the credit limits they will establish with each consumer. "When they gather all of the [relevant] information for a consumer, and that leads them to cut or deny credit to that customer, it becomes increasingly difficult for me to argue [against it] based on my—the marketing people's—relationship with the buyers," Goodman says. "It can be frustrating, but it's necessary in our marketplace." Goodman says that's a change he noticed once OmniSource purchased his employer, Carolinas Recycling Group.
And the flow of scrap is beginning to find its balance. Goodman says he hears of less scrap available in the marketplace all around the United States. Volumes and prices are likely to remain low until the overall economy recovers. "We're not going to see much recovery in price until we see recovery in industrial production," Garino says. "Contracts have been broken, trust has been affected, but demand will return again." Countries such as China, India, and Brazil are the likely drivers of long-term economic growth and eventually will dominate this cyclical downturn, he says. Payment problems should go away when scrap prices return to a more normal pattern of fluctuation.
This crisis in international scrap will eventually come to an end, these sources say, and the industry might turn out stronger because of it. Though "scrap is bought, not sold" has long been an industry maxim, Stein says the long-term trend favors scrap dealers. "We'll be able to pick and choose with whom we do business. Good customers, those who honored their commitments, will be the ones that will be able to purchase scrap in the future." •
Ann C. Logue is a writer based in Chicago.
In the aftermath of last fall's economic collapse and the ensuing trade problems, scrap sellers are seeking new measures to protect themselves in agreements with foreign buyers.