China is still one of the top choices for companies’ manufacturing operations worldwide. According to Deloitte’s 2016 Global Manufacturing Competitiveness Index, China is the most competitive manufacturing nation, with cost competitiveness being a significant factor. Although there are many important parts involved in getting your product(s) manufactured in China, the most important is your contract. This article will offer tips for Chinese manufacturing contracts, as well as a short description of some of the most important provisions to include in your contract.
Always work with an attorney:
Keep in mind, you should always hire an attorney to negotiate and write your manufacturing contract for you. Furthermore, we highly recommend that you hire a local attorney who speaks both Chinese and English fluently. Never use a template, but rather work with your local attorney to draft an agreement(s) for your specific company and manufacturing relationship.
Get your contract in writing:
Always have a written contract for all business activities in China, written in Chinese. Written in Chinese means your contract should be written in the Chinese that is used in the area your partner is located in, not translated into Chinese from another language or from Hong Kong to the mainland. This is important because things can and often do get lost in translation.
Many Chinese manufacturers like to use supply agreements (templates) that look like nothing more than a purchase order. Manufacturers say they prefer these supply agreements because they save time, but the more likely reason is because they don’t protect buyers in the ways they should. Do not fall for this, take the time to draft a manufacturing contract that will protect your interests. Remember though, if your contract is too stringent, no manufacturer will sign it.
Manufacturing contracts vary by company, but there are many provisions that are universally included in Chinese manufacturing contracts. Below are some of the most important and commonly included provisions.
Pricing: Detailed pricing provisions should be included in your agreement. Manufacturers will not shy away from asking for more money several months after signing the agreement, often citing inflation and rising labor costs. Detail any specific pricing agreements you want, such as fixed prices for a specific period of time, volume discounts, specific pricing models based on the bill of materials, or any other type of pricing adjustment mechanism. If you sell some products in China and export some to sell elsewhere, you will need more than one pricing model to account for the impact of VAT and title transfer rules on the exported products.
Bill of Materials: A bill of materials (BOM), a list of exact components, brands, and where those components come from to be used in fabricating the product, should be included in your agreement. A BOM will help prevent your manufacturer from substituting cheaper materials and components at his discretion.
Inspection and Quality Requirements: Include detailed product and packaging specifications, quality control, and inspection procedures. Your contract should permit you (or someone you designate) to inspect your goods at any time before the goods are shipped and before you have made your final payment. You may want to allow yourself the opportunity to inspect the products before shipping and after arrival at the final delivery location.
Product Warranty: Today many more manufacturers are willing to offer product warranties against product defects for which they are responsible. The warranty period is generally measured from the date of shipment since manufacturers won’t know your date of sale.
Rejected Goods: Include a provision that clearly sets out what your manufacturer must do with your rejected goods and the amount your manufacturer must pay you if he does not abide by this rejected goods provision. You may also want a clause that the percentage of rejects is limited to a certain amount of the overall project.
Tools, Jigs, and Mold Ownership/Return: Include a provision that all tools, jigs, and molds belong to you and must be returned to you when your relationship ends. Include in this provision a penalty fee (contract damages) to be paid if the manufacturer fails to return these items to you or uses them to manufacture other products for other companies.
Suppliers: Include a provision that requires that if your manufacturer wants to use a new supplier, he must get your permission first.
Subcontractors: Include a provision that outlines your manufacturer’s use (or prohibition of the use of) subcontractors. Most experts recommend that you forbid your manufacturer from using subcontractors. If you do allow your manufacturer to use subcontractors, make sure your manufacturer remains liable for anything subcontractors do. Furthermore, you should also consider a requirement that your manufacturer inform you of and get your permission to use subcontractors, including permission for specific subcontractors.
Marketing or Selling Your Product to Others: Include a provision that prohibits your manufacturer from marketing or selling your product to anyone other than you, even after you terminate your relationship. The manufacturer likely has no interest in selling your product, but might be interested in selling your IP for profit.
Selling to Customers Directly: Include a provision that prohibits your manufacturer from selling your product directly to customers. Like the above provision, this can be laid out in an enforceable (in China) NNN (non-use, non-disclosure, non-circumvention) agreement.
IP Protection: Even if you have already registered your IP in China, you may have know-how and trade secrets that are not registerable. If that is the case, your know-how and these trade secrets should be protected in your manufacturing contract. Furthermore, you should address your manufacturer’s work with competing companies (whether that is permissible) and how/if production teams and lines will be segregated.
Contract Damages for IP Infringement: Specific contract damages should be laid out and described your agreement because they are most effective and a preferable remedy for IP infringement in China.
Dispute Resolution: Include detailed provisions on how disputes will be resolved. Because different disputes may be better resolved in different manners, you should consider the best dispute resolution, including resolution process, for each type of dispute. For example, when your manufacturer doesn’t meet product specifications or deadlines, you may want to try to work that out together before initiating a formal resolution process.
Consider dispute resolution processes and locations:
Experts disagree on the best way to make a Chinese manufacturing contract enforceable. Some experts say that your contract should be governed by Chinese law and enforceable in Chinese courts. Other experts say that it depends on the type of remedy you seek. For example, if you are a US company and you want monetary damages and arbitration, that should occur outside China and be governed by US law because China is bound to recognize foreign arbitral awards, but not US court judgments. Conversely, if monetary damages will not resolve the dispute, you may want to resolve the dispute through litigation in China. For example, if your manufacturer violates your manufacturing contract, you may want an injunction, which must be handled in Chinese courts.
There are many benefits to manufacturing in China, but for foreign companies, those benefits must be weighed by the difficulties of doing business with a foreign manufacturer. A sound manufacturing agreement is a great way to protect your business in China. While the provisions discussed above are important to include in a manufacturing agreement, your attorney should draft an agreement for your specific business and manufacturing relationship.
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