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Structuring the Purchase of Rubber Gloves from Malaysia: Avoiding Risks During the Pandemic

The COVID-19 pandemic has taken a hit on all of Malaysia’s industrial players in every sector, with exception of one – glove manufacturers. For reasons of health and safety, a booming worldwide demand sees a global shortage of gloves. It is a rare occurrence that a Malaysian manufactured commodity has attracted such a high demand from the global market. Malaysian companies involved in the manufacturing of gloves are currently trading at a high ‘Price-to-Earning’ ratio. One of the largest glove manufacturers in Malaysia occupied second place in the market capitalisation under Malaysia’s public listed companies in early November 2020. Due to this surge in demand, global buyers are placing orders in advance, in some instances, and securing the supply over the next 12 months. Payment terms in these transactions are often made in advance or with a secured mechanism to protect both the buyers and suppliers.

The demand for gloves has skyrocketed due to the COVID-19 pandemic, and although the demand tapered slightly after the commercialisation of vaccines, this inflated global demand has also resulted in a rise of cases involving individuals and entities who have taken advantage of the high demands of gloves to present fraudulent statements to potential buyers and in turn siphoning money from them and scamming a large number of buyers. With the rise of these scam, a leading Malaysian glove manufacturer initiated lawsuits1 against “glove scammers who claimed to be authorised agents or representatives of the rubber glove manufacturer”. The lawsuits shed light on the precautionary measures that should be taken by potential buyers, especially those who are unfamiliar with Malaysia’s legal landscape and business environment, to avoid business risks when purchasing gloves from Malaysia.

 

1. PROTECTIVE STEPS

1.1 Conducting Business Due Diligence

Purchasers are bound by the principle of Caveat Emptor or “let the buyer beware2” where the purchaser has a duty to assess the potential risks they may face. A failure to do so will result in the purchaser having no recourse available to them if the goods fail to meet expectations barring fraud. It is prudent for the purchaser to conduct a meticulous assessment of risks in the form of due diligence when considering the perils associated with large international transactions.

A thorough and well executed due diligence exercise will provide the purchaser with a comprehensive idea of the legal standing of relevant counterparties or promoters, and as such mitigating the potential risks faced and avoiding potential litigious action.

1.2 Appointing Legal Representatives

One of the common issues in these types of transactions is the ownership of the goods – in this case, gloves. Subject to the existence of an agreement between the parties, the ownership of the gloves is typically held by the glove manufacturer as they are the producer. However, in most instances purchasers will order the goods from promoters who normally claim to be entitled to product allocation. The red flag here is that the promoters do not necessarily hold the title of ownership to the gloves, pursuant to the principle established in the nemo dat quod non habet rule, purchasers of the goods will fail to acquire the title of goods if they are bought from a person who is neither the owner of the goods nor has the authority from the owner to sell the goods3. Consequentially, the purchaser might never acquire a good title over the gloves despite the bona fide transfer of money as a purchase payment to promoters. This can be avoided through the appointment of legal representatives who are able to verify the source of gloves, production facilities, and the delivery mechanism.

Furthermore, when a purchaser either approaches or is approached by a promoter claiming to be an allocation holder, the parties may not be on equal footing as the latter party tends to be more familiar with the nature of such transactions and the industry. Hence, the appointment of legal representatives is advised to ensure that the interests of the purchaser are well-protected, and the transaction is legally executed and ultimately one can avoid commercial fraud.

1.3 Appointing Local Lawyers

Though the Malaysian legal system is very similar to the English legal system, numerous new pieces of local legislations have been enacted and are fertile in application. Thus, engaging local lawyers is vital to assess the legitimacy of transactions and ensure full compliance with local laws. Qualified Malaysian lawyers would be able to assist prospective purchasers within the purview of Malaysian commercial cases and legislations such as the Contracts Act 1950, Sale of Goods Act 1957 and Competition Act 2010. We have observed a pattern wherein prospective purchasers are also comfortable to rely solely on their respective home jurisdiction’s lawyers in the transaction. Despite such foreign lawyers having the reasonable skills possessed by a practitioner, a local lawyer may have a deeper understanding and familiarity of the legal issues at hand and can appropriately appraise a full assessment of risks.

Upon appointing local lawyers, the purchaser can run a search through a legal directory on the Malaysian Bar’s official website4 to seek qualified and practising lawyers under the Legal Profession Act 1976. Alternatively, the purchaser can consider browsing through the legal publication awards in Malaysia such as the Asian Legal Business Malaysia Law Awards5 or the Legal 500 Malaysia6 to gain an insight of various established law firms in Malaysia in order to engage their preferred lawyers in the nation.

 

2. WORKING OUT TRANSACTION STRUCTURE

2.1 Devising Proper Sale & Purchase Agreement (“SPA”)

The next steps to take in the transaction is to devise a proper SPA between the parties. The typical transaction for the purchase of gloves, although relatively straightforward, should not be underestimated. An overview of the process is outlined below.

Firstly, the purchaser issues a letter of intent to purchase gloves and proof of funds, optionally coupled with a non-circumvention, non-disclosure agreement if an intermediary is present or if negotiations are to be kept confidential. A letter of intent is generally not legally binding on the parties save as when the contents therein reflect a legal consideration and intention to create legal relations7. Subsequently, the vendor reverts with a full corporate offer, to which the purchaser may accept with a letter of acceptance and an irrevocable corporate purchase offer, making the transaction legally binding. Thereafter, the SPA is entered into by both parties.

The SPA typically addresses the payment structure and delivery arrangement, with the purchaser commonly being able to exercise its right to inspect the delivery alongside SGS reports. Upon satisfaction, the full purchase funds are duly released in accordance with the SPA. Additionally, the purchaser may check if the vendor holds a valid license issued by the Malaysian Rubber Board under the Malaysian Rubber Board (Licensing and Permit) Regulations 2014 in regard to the export of gloves8. This critical aspect, although seemingly small, may determine the vendor’s eligibility in carrying out the transaction.

 

3. Bank Guarantee and Escrow Agreement

Supplemental to the SPA, a bank guarantee may be taken out by a party in favour of a beneficiary, such that the bank acts in the capacity akin to a guarantor. In the event that the party defaults on his contractual obligations, the beneficiary calls upon the bank guarantee in the form of a written demand whereby the bank has to honour the call and meet the beneficiary’s claim. Hence, a bank guarantee is often an instrument put in place by contracting parties to protect them from financial losses. The parties should be alerted to issues such as ambiguity which could affect the validity of bank guarantees. Fundamentally, the court categorized bank guarantees9 as follows:

  1. no more than a mere written demand is required;
  2. the demand must assert a failure to perform the contract; or
  3. because of the word ‘damages’, proof thereof and not mere assertion is required before liability under the bond arises.

To identify the bank guarantee in question, the courts perform a straightforward exercise of construction or interpretation of the guarantee to discover the intention of parties.

Moreover, the contracting parties may consider entering into an escrow agreement with a third party managing the escrow fund as an escrow agent. An escrow agreement is a tripartite agreement governing the relationship of parties, particularly the escrow agent’s duty to utilise and dispose of the fund deposited into an escrow account. It is noteworthy that the Malaysian banking system allows the escrow fund to be kept in US or Euro currencies while the release of said monies is effected to the respective parties.

The duties of escrow agents are only those specifically provided for in the agreement and they are in no way liable to the contracting parties except for wilful misconduct or gross negligence on their part10. It is crucial that the escrow agent is a neutral stakeholder who does not solely represent or act in the interests of either party. In this regard, the parties may appoint a reliable lawyer with integrity to act as the escrow agent to manage the escrow fund. Law firms like our firm, may also act as an escrow agent.

3.1 Logistics and Shipping

Appropriate terms for shipping can be achieved through the incorporation of International Commercial Terms11 (“Incoterms”) for shipping through sea and inland waterway transport into the agreement. The two most common Incoterms are the Cost, Insurance and Freight (“CIF”) agreement and the Free on Board (“FOB”) agreement.

The CIF holds the vendor responsible for the carriage cost, export clearance, procuring minimum insurance coverage for the carriage, arranging the carriage of gloves to the named destination port, and carrying the risk of loss or damage to the gloves until delivered on board the ship. The purchaser assumes the remaining responsibilities including unloading at the destination port and import clearance. Therefore, the CIF favours the vendor as they retain the most control over transit times and associated transport costs, and because risks from loss or damage pass early to the purchaser.

In contrast, the FOB holds the vendor responsible for the carriage costs to the shipment port, port handling costs, export clearance, and carrying the risk for loss or damage of gloves until they are on board the ship. The purchaser assumes the remaining responsibilities including arranging the contract of carriage from the shipment port, the carriage cost, and import clearance. Hence, the FOB favours the purchaser as transit times and associated transport costs are controlled by the purchaser, allowing for a more cost-effective and efficient shipment.

However, these Incoterms are only general terms setting out obligations, risks, and costs in respect to the goods’ delivery. This necessitates a robust SPA being in place to provide for other aspects of a contract such as specifications of the goods, remedies available for breach of contract, the effect of sanctions, and the imposition of tariffs12. The rules for Incoterms do not prohibit alteration of Incoterms13, providing room for customisations14. Hence, purchasers are strongly advised to seek assistance from legal professionals to negotiate and subsequently draft the contract of sale based on mutually agreed terms.

The second possible consideration for purchasers is the port from which goods are to be shipped. Port Klang is the largest port in Malaysia in terms of import and export quantities, and the second largest for transhipment quantities15. In fact, one of the largest glove manufacturers in the world has positioned 26 factories in the surrounding Klang area16. The process flows for import and export activities at Port Klang have also been developed. These refine the export procedures through detailing document preparation, customs clearance, technical control, port and terminal handling, and inland transportation and handling, making the entire process more streamlined17.

To conclude, in the wake of escalating fraudulent schemes amidst the COVID-19 pandemic, one must be vigilant and is advised to make thorough considerations when entering into a transaction to purchase gloves, more so if one deals with intermediary companies. The prospective buyer should undertake the necessary due diligence to scrutinise the legal aspects of the transaction and verify the credentials of counterparties. Furthermore, without obtaining sophisticated legal advisory services from legal representatives or lawyers, the buyer may expose itself to a high degree of transactional or financial risks. Regardless, it is a good practice that the transaction structure’s details are ironed out with a proper SPA. Procuring bank guarantees and engaging escrow agents are examples of safety nets which may be adopted by the purchaser. The international transportation terms for the goods should also be subject to the parties’ mutual agreement. The foregoing action points should always be taken into account and in contemplation of the purchaser to secure a successful glove purchase transaction, for the law is aiding and inclining toward the vigilant and not the dormant.

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1. https://www.theedgemarkets.com/article/hartalega-takes-legal-action-against-glove-scammers-urges-buyers-stay-vigilant
2. Wallis v Russell [1902] 2 I.R. 585
3. Ng Ngat Siang v. Arab-Malaysian Finance Bhd. @ Anor (1988) 3 MLJ319
4. Malaysian Bar, ‘Find A Lawyer”, https://legaldirectory.malaysianbar.org.my/
5. The Legal Business Online, “Asian Legal Business”, https://www.legalbusinessonline.com/law-awards/alb-malaysia-law-awards-2020
6. The Legal 500, “Asia Pacific – Malaysia”, https://www.legal500.com/c/malaysia/
7. Guthrie Waugh Bhd v Malaiappan Muthuchumaru [1976] 2 MLJ 62
8. Regulation 3, 4 and 5 of Malaysian Rubber Board (Licensing and Permit) Regulations 2014
9. Konajaya Sdn Bhd v Perbadanan Urus Air Selangor Bhd [2009] 5 MLJ 263
10. Halley v Law Society [2003] EWCA Civ 97
11. International Commercial Terms are jurisdiction-neutral terms. (International Commercial Terms 2020 by the International Chamber of Commerce)
12. Introduction to Incoterms 2020 by the International Chamber of Commerce
13. Incoterm Rules of 2020
14. Introduction to Incoterms 2020 by the International Chamber of Commerce
15. Port Development in Malaysia (https://www.rvo.nl/sites/default/files/2020/10/Port%20Development%20in%20Malaysia%20An%20introduction%20to%20the%20countrys%20evolving%20port%20landscape.pdf)
16. Top Glove Factory List (https://www.topglove.com/more-factories/)
17. Ministry of Trade and Industry – National Single Window Business Process Reengineering (NSW BPR) Working Group (https://www.miti.gov.my/index.php/pages/view/914)

 

Prepared By:

Chong Han Jie (Associate) chonghanjie@azmilaw.com

Loni Lee (Associate) lonilee@azmilaw.com