Counterparty Due Diligence Before You Sign

In business, the greatest fear isn't low margins—it's delivering goods or services only to find the counterparty has gone bankrupt, leaving you with a winning judgment that isn't worth the paper it's printed on. In practice, many small and medium-sized enterprise (SME) owners sign contracts based on how grand an office looks or how impressive a business card title sounds. They overlook the most fundamental step: Due Diligence. Determining whether a partner is about to collapse isn't a matter of intuition; it is a matter of data and statutory analysis. I will break down how to see through a counterparty's facade using business registration, credit checks, and contractual defense mechanisms.

Unmasking the 'Paper Company': The Deep Meaning of Registration and Paid-in Capital

Many people believe that if a company appears in the Ministry of Economic Affairs' 'Commerce Industrial Guidance Portal,' it is safe to deal with. This is a massive misconception. According to Article 12 of the Company Act: 'After the registration of a company, any matter that should have been registered but was not, or any registered matter that has changed but was not updated, cannot be used as a defense against a third party.' This means that while the registration is the company's 'ID card,' having a valid ID doesn't mean they have the money to pay their debts.

First, you must look at 'Paid-in Capital' rather than 'Authorized Capital.' Authorized capital is merely the upper limit of shares the company intends to issue in the future. Paid-in capital is the actual cash or assets the shareholders have contributed. If a company claims to handle multi-million dollar projects but has a paid-in capital of only $500,000, that is a glaring red flag. Read Article 9 of the Company Act alongside it, which stipulates that shareholders must actually pay in their capital contributions and cannot withdraw them after payment. While we cannot see their bank statements directly, if a company frequently changes its capital amount or if the capital is completely disproportionate to its scale of operation, you must be wary of the legal risk of 'sham capital.'

Second, observe the 'Responsible Person' and the 'Board of Directors.' If a company's representative changes frequently, or if the board consists of numerous corporate entities whose ultimate controllers are untraceable, this is often a sign of internal instability or a planned 'exit strategy.' Under Article 23 of the Company Act, the responsible person of a company shall conduct the business of the company faithfully and exercise the due care of a good administrator. If the responsible person has a history of personal debt disputes, even if the company appears normal now, it will be difficult to hold them personally liable when things go south.

In my experience, the most dangerous companies are those that look the part but have no 'meat' on their bones. A company with a high authorized capital but low paid-in capital is essentially telling you they have big dreams but no skin in the game. When you see this, you aren't just looking at a financial metric; you are looking at a lack of buffer. If a single project fails, they have no equity to absorb the blow, and you, the creditor, will be the one left holding the bag.

Three Red Flags in Credit Checks: Litigation, Taxes, and Labor Disputes

Beyond registration, you must take the initiative to conduct credit checks using public information. In practice, I recommend running at least these three processes before any significant deal.

1. Judicial Search System: Enter the full name of the counterparty into the Judicial Yuan's judgment search system. Don't just look for whether they have lost a case; look at the 'Type of Case.' If you see a surge in civil cases regarding 'Payment of Price,' 'Payment of Negotiable Instruments,' or 'Payment of Wages' in the recent six months, it indicates a liquidity crisis. They aren't just being difficult; they literally cannot pay their suppliers, banks, or employees. Bear in mind that published judgments lag by months or longer, and that only disputes which reached litigation appear at all — anything settled, pursued by payment order, or still at the demand-letter stage will not show up. So there is no count of cases that marks the point to walk away. What to read is the pattern and the type: the same category of payment claim recurring over a short window says the cash-flow problem has become structural rather than incidental. In court practice, once a company starts losing 'Payment of Price' suits, it is usually a precursor to a total freeze of assets.

1. Negotiable Instruments and Tax Delinquency: Check the Taiwan Clearing House for any 'Bounced Check Records.' Although the use of physical checks has declined, for traditional industries, a bounced check is the most direct evidence of credit insolvency. Simultaneously, the Ministry of Finance announces 'Major Tax Delinquents.' While small tax debts aren't public, if a company has reached the point of being blacklisted for taxes, it is usually the final straw before bankruptcy. Article 254 of the Civil Code states that when a party is in default, the other party may fix a reasonable period for performance, and if not performed, may rescind the contract. However, if you wait until their assets are seized for back taxes, rescinding the contract is often too late to recover any value.

1. Labor Standards Violations: This is an often-overlooked indicator. If a company frequently violates the Labor Standards Act—such as failing to pay wages or overtime—it signals not just poor management but extreme cash flow pressure. Article 27 of the Labor Standards Act allows the competent authority to order an employer to pay wages within a specified period. When a company starts 'saving' on its own employees' salaries, do you really think they will prioritize paying an external supplier? A company that treats its internal stakeholders as interest-free loans is a company that has already lost its moral and financial compass.

I have seen many SMEs ignore these signs because they were 'too busy' or felt it was 'impolite' to check. Let me be clear: checking a partner's litigation record is not an insult; it is professional hygiene. If they are clean, they won't mind. If they aren't, your 'politeness' will cost you your business.

Contractual Body Armor: Using the Civil Code to Build Warning and Exit Mechanisms

If your search reveals that the counterparty is 'slightly risky' but you still want to take the deal, your contract clauses are your final line of defense. You cannot rely on a standard template; you must insert aggressive defensive provisions.

First, utilize the 'Defense of Insecurity.' Article 265 of the Civil Code provides: 'A party who is bound to perform his part first may, if after the conclusion of the contract the property of the other party has obviously decreased whereby the counter-performance is jeopardized, refuse his performance until the other party has performed his part or given security for the same.' In your contract, you should specify what constitutes this jeopardy. For instance, you can agree that if the counterparty's credit rating drops, if they are subject to compulsory execution, or if their bank accounts are frozen, you have the right to immediately stop delivery or services without being in breach.

Example Clause: "In the event that a party is subject to compulsory execution, bankruptcy, reorganization, suspension of business, or there is evidence of credit impairment, the other party may immediately suspend the performance of its obligations under this Contract and require the party to provide adequate security within three days. If the party fails to provide such security, the other party may terminate or rescind this Contract and claim damages."

Second, require a 'Personal Guarantee from the Responsible Person.' For SMEs, the company might be broke, but the owner often still has assets. According to Article 272 of the Civil Code, a joint and several debt is one where several persons assume the same debt, and each is liable for the whole performance. Having the owner sign as a joint and several guarantor prevents them from using the 'bankrupt the company, start a new one' trick to evade debts. If the owner refuses to sign, it shows they lack confidence in their own company's ability to pay.

Third, set 'Set-off Rights' and 'Acceleration Clauses.' If both parties have mutual debts, you should agree on set-off rights under Article 334 of the Civil Code. Pair it with an Acceleration Clause, stating that if the counterparty fails to pay any single installment, all remaining payments shall become immediately due. This allows you to obtain an execution title for the full amount at the first sign of trouble, allowing you to seize assets before other creditors arrive.

FAQ

If a company has a high capital amount, is it absolutely safe?

Not necessarily. Capital is just the money 'once' invested; it doesn't represent current cash on hand. Many companies transfer funds out after registration (which may violate Article 9 of the Company Act) or have a negative net worth due to losses. Capital must be viewed alongside recent litigation records. A high-capital company with multiple lawsuits for unpaid debts is just a hollow shell.

If I find a litigation record, must I refuse the contract?

It depends on the nature of the suit. Intellectual property disputes or contract interpretation disagreements are normal business risks. However, suits for 'Payment of Price,' 'Payment of Negotiable Instruments,' or 'Application for Payment Order' indicate a failure to meet basic financial obligations. Even one such case in the recent past should be a major warning sign.

What if the counterparty is a newly established company with no history?

New companies have no past, so you must look at their 'future.' In these cases, a 'Personal Guarantee' from the responsible person is non-negotiable. Shorten the payment cycle as well—using 'Prepayment' or 'Cash on Delivery' (COD)—and consider requiring a Performance Bond from a bank to shift the risk to a financial institution.

Is there a risk if the person I'm talking to isn't the 'Responsible Person' on the registry?

A significant risk. This could be a 'nominee company.' Under Article 8 of the Company Act, the responsible person includes directors. If the actual operator refuses to be the registered representative, they are often trying to avoid tort liability under Article 184 of the Civil Code or compensation liability under Article 23 of the Company Act. Always ensure the person signing has legal authorization, and ideally, have the registered representative sign personally.

Can we agree that 'the contract terminates automatically if the counterparty's assets are seized'?

Yes. This is an extension of the right of rescission under Articles 254 to 256 of the Civil Code. Legally, this is known as a 'Contractual Right of Termination.' Clearly listing these triggers allows you to bypass the tedious legal notice process and retreat quickly before the counterparty's assets are completely depleted by other creditors.

If I can't see their financial statements, how else can I assess credit?

Observe their 'Labor Insurance Enrollment' and 'Office Stability.' If a company has high employee turnover or moves offices frequently, these are signs of financial instability. Industry gossip is worth listening to. If suppliers are whispering that a company is 'slow to pay,' do not become the next victim. Word of mouth in the supply chain often precedes a court filing by several months.

Six Checks to Run Before Signing

1. Have you verified the 'Paid-in Capital' and the identity of the 'Responsible Person' in the official commerce registry?
2. Have you checked the Judicial Yuan system for any recent 'Payment of Price' or 'Payment Order' litigations against them?
3. Have you confirmed that the company has no major bounced checks or public tax delinquency notices?
4. Does the contract include 'Defense of Insecurity' and 'Acceleration' clauses reflecting the spirit of Civil Code Art. 265?
5. For high-risk transactions, have you secured a 'Joint and Several Guarantee' signed by the responsible person in their personal capacity?
6. Have the payment terms been adjusted (e.g., higher deposit or shorter cycles) based on the counterparty’s credit profile?

Business is built on trust, but trust must be anchored in legal defense mechanisms. A five-minute check before signing can save you from five years of litigation. Remember, the law does not protect those who sleep on their rights, and it certainly doesn't protect those who close their eyes in the face of obvious risk.