How & why to create a valid China manufacturing contract

2020-09-15

In This Episode... We're discussing manufacturing contracts. These are an essential piece of the puzzle for buyers with suppliers in China or elsewhere in Asia as they provide you with a way to clarify your requirements with your supplier, outline your expectations and the penalties for if they aren't met, protect your IP from being used or distributed incorrectly, and provide a legal framework to take action if things go wrong. Hopefully, if you have an enforceable contract you will never need to resort to litigation, but...

In This Episode...

We're discussing manufacturing contracts. These are an essential piece of the puzzle for buyers with suppliers in China or elsewhere in Asia as they provide you with a way to clarify your requirements with your supplier, outline your expectations and the penalties for if they aren't met, protect your IP from being used or distributed incorrectly, and provide a legal framework to take action if things go wrong.

Hopefully, if you have an enforceable contract you will never need to resort to litigation, but we do touch on this, too.

Show Notes

Start to 02:47 - Introduction & do buyers work with suppliers without a manufacturing contract? - this is fairly common, but the idea that contracts are not enforceable in China (which is fairly prevalent) just isn't the case.

02:47 to 05:30 - What makes buyers feel secure enough not to use a contract when dealing with Asian suppliers? - this could be down to a lack of awareness about the need for a specialized manufacturing contract that is enforceable in, say, China, because they're used to not requiring a new contract per project in their countries. They may not know about the risk-reducing benefits of a valid contract, especially where larger orders are concerned.

05:30 to 07:53 - Payment terms which can help mitigate your risks - exploring preferential payment terms which may be acceptable to suppliers if large orders are placed, such as paying by letter of credit or paying a 20% downpayment and the balance after delivery.

07:53 to 12:22 - What are the benefits of having a valid and enforceable manufacturing contract? - outlining key benefits. The number one is the ability to outline and clarify your expectations to the supplier and have them commit to it in writing. Using a clear quality standard as an attachment is also important here.
The second key benefit is the extra leverage that the contract provides to buyers in the event that something goes wrong.

12:22 to 25:45 - What is included in a manufacturing contract - there are roughly 3 elements to consider (although this will depend on your needs and the type of supplier you deal with) and we'll go through them one by one:

Confidentiality agreement - China NDA or more comprehensive China NNN agreement - this will prevent the supplier from sharing your IP, using it to compete against you, or reaching out to your customers behind your back. Note - keeping penalties sensible is important.
Product Development Agreement (PDA) – (if developing product/s with your supplier) - this controls who will own the IP and outlines who financed what, etc. This will help you to move to new suppliers and take tooling and designs with you if needed.
Manufacturing Agreement (MA) - this outlines what you want the supplier to commit to. Product, spec, quality standard, price, shipment date, etc. It takes away any ambiguity and makes your requirements 100% clear.

25:45 to 27:05 - Further discussion about when these 3 elements may or may not be appropriate - for instance, if a Chinese supplier has rightfully developed the product that you are, say, white-labeling, then it is not appropriate to insist on a clause of exclusivity for the design.

27:05 to 31:53 - What else should go into the manufacturing agreement? - you may include payment terms, a clause about access to their factory for audits and checking, that no sub-contracting is allowed, the inspection process, and when products will be allowed to ship (contingent on passing inspection), what happens if products are received, but many quality issues are found - Why many lawyers struggle to distinguish between manufacturing and design defects which can lead to conflict between supplier and customer if the wording of the contract is not clear on this point and defects occur after some time that the products have been in the field (which would usually indicate a design defect, not a manufacturing defect that the supplier would be responsible for unless they developed the product, too) - also clauses on when a supplier may be sued or termination of the contract can be actioned.

31:53 to 34:36 - Manufacturing contract templates and contract depth - the length and depth of your contract is influenced by the size and type of supplier you work with and your order size and complexity. A small supplier may not have the bandwidth to deal with a very long and detailed contract.

34:36 to 36:40 - The strength of the manufacturing agreement to remove ambiguity - how the contract keeps everything in black and white and prevents managing a project via skype, wechat, email, etc. This could cause problems if trying to find fault for issues, in comparison to a contract where everything is clear and simple.

36:40 to END - How realistic litigation is if there are problems - this will depend on the contract. If it's not enforceable in your supplier's country litigation will be harder, but holding the supplier accountable in general will be affected. The dangers of being 'too trusting' and not planning ahead for the worst-case scenario.

*Please note, we are NOT lawyers. Any information provided in this episode is of an casually informative nature, but we recommend contacting a lawyer who is familiar with China/Asian law to help you produce your manufacturing contract.

Extra information you may find helpful

China Law Blog articles by Steve Dickinson - often focusing on manufacturing contracts and similar topics
On the Sofeast blog: How To Create A Valid Manufacturing Contract In China To Protect Your IP

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