An agreement will give you complete peace of mind knowing that your rights are protected. It will also ensure that you can take action in case the manufacturer fails to deliver.
Forming a manufacturing contract with a China-based manufacturer can be challenging. This is due to the uncertainties around what to include in the contract, its jurisdiction, and the language to use.
Here we take a deep dive into the key points on signing a manufacturing agreement in China, what to include, and the rules around its enforceability.
The pandemic slowed down manufacturing and trade activities across the world, with China being no exception. Despite the slump in the first quarter of 2020, China's exports accelerated in October, rising 11.4 percent above 2019 figures to reach USD 237.2 billion.
The growth continued in 2021, fueled by solid global demand. Shipments in August 2021 showed a 25.6 percent year-on-year growth, while the growth was 19.3. percent in July per Customs data. The resilient industrial sector witnessed a rebound in consumer goods and wholesale outdoor products, including recreational products, furniture, and electronics. As the world's largest exporter, China has maintained its focus on exports to achieve growth, emerging as the top export partner for European and U.S. markets.
Whether you are looking to outsource the manufacturing of wholesale outdoor products, wholesale outdoor gear, or other consumer products, there are multiple factories in China that manufacture such products. Before you go ahead and finalize your deal, it is important to sign a manufacturing agreement with the Chinese supplier.
Going ahead with a China manufacturer without having a clear agreement in place exposes you to multiple risks. These include deviation from the agreed price, date of delivery, quality of the product, and compromised trade secrets.
For instance, a startup company in the U.S. puts in extensive efforts to promote its products during the holiday sales season and receives enough orders. These orders have to be delivered in specific amounts, at a specific rate, and time. The buyers in the U.S. insist on drawing up a binding contract that the startup company is obliged to adhere to.
After receiving these orders, the startup contacts a Chinese manufacturer to submit an order. The Chinese manufacturer, while initially agreeing, demands a higher rate after a few days or can suddenly say they do not have the manufacturing capacity to complete the order.
This will mean the startup has to face a lawsuit in the U.S. for breach of contract as it fails to meet its contractual obligations. Failure to meet the obligations of the contract not only impacts the startup's financial health but destroys its credibility. If the startup was under the illusion that the Chinese supplier had a binding contract with the company on all terms, the sudden turnarounds would come as a complete, unpleasant shock.
There are also instances when a factory in China that manufactures a product for an American or European buyer secretly registers the buyer's trademark in China. There can be instances where they produce a similar product for the buyer's competitor.
A well-drafted China manufacturing agreement addresses these issues and defines the basic terms for buying the manufactured product. The key terms relate to the date of delivery, quantity, quality, and price. The manufacturing agreement also protects your trademark and Intellectual Property (I.P.).
A binding manufacturing agreement with your Chinese supplier helps prevent unpleasant surprises down the line and ensures the supplier and you are on the same page throughout the trade process. Knowing what points to focus on when signing a manufacturing agreement with your China supplier is the first step to formulating a well-thought-out agreement.
The manufacturing agreement clearly defines the various terms and obligations of the buyer and the supplier, including:
The production equipment the manufacturer will use
Quality inspection procedures
Type of packaging
Breach of contract
A manufacturing agreement should also protect you from unauthorized subcontracting. It can happen at times when the manufacturer is unable to manufacture the entire product or the required quantity and decides to subcontract.
This can mean the buyer is unaware of where their product was eventually produced. This can compromise product quality or increase the risk of production delays, I.P. theft, and other ethical issues.
Ensure the manufacturing agreement in China mentions that subcontracting is not acceptable to mitigate these risks.
NDA or Non-Disclosure Agreements are designed to protect your trade secrets by preventing their disclosure to the public. While American companies rely on the NDA agreement drawn up in English to prevent disclosure of their trade secrets, this type of agreement may not suffice in China.
The China supplier does not reveal your trade secrets to the general public. However, there have been instances where a factory steals the product idea to make similar products. Your manufacturing contract with China suppliers has to specify that the Chinese company cannot use the trade secret to compete with you by making a similar product.
The Chinese equivalent to NDA is NNN Agreements that protect your trade secrets and confidentiality when working with China manufacturers. NNN agreements have non-use, non-disclosure, and non-circumvention clauses. Being an upgraded and more comprehensive version of the non-disclosure agreement, the NNN offers these types of protection:
Non-use– Manufacturers cannot use your intellectual protection/ trade secrets in any way
Confidentiality – China suppliers cannot disclose or share your I.P. with others through unauthorized subcontract or any other way
Non-circumvention –No manufacturer can make and sell your products to your customers
The NNN is particularly important when you have a unique product idea, whether it relates to wholesale outdoor gear or other products.
Disputes related to ownership of tooling and molds can and do occur when it comes to manufacturing in China. If you choose to work with a China manufacturer without carrying out due diligence, the risk of such disputes arising increases. Unscrupulous manufacturers know that another factory cannot immediately make the product without the tooling or molds. They can leverage the tooling or molds to hold you hostage.
Specifying that you own the tooling/mold at all times in the manufacturing agreement and including a list of the tools you own will help mitigate this risk. If you are lending your existing tooling and molds to the manufacturer, ensure you take a deposit and mention the deposit amount in the agreement.
Consider a liquidated damage provision that ensures you can claim a certain amount of damages in case the Chinese manufacturer does not return your tooling promptly back to you. Including the damage provision in the contract gives a basis for the Chinese court to freeze the assets of the manufacturer before the final judgment is given. When the factory owner is aware of this, they are less likely to use your molds or tooling against you.
Are you looking for product design and development assistance from China manufacturers? Whether you are looking to sell outdoor products made in China or other products that need to be designed and developed in China, the PDA comes into play.
Many Chinese manufacturers help startups and small enterprises in the U.S. and Europe design and manufacture their products. Without a PDA, the Chinese supplier can claim they own your I.P. as they helped you develop your product.
The PDA enables you and your China supplier to agree in advance on:
Products to be designed and developed.
Technology the Chinese manufacturers and the foreign company contribute
Who provides product specifications
Who owns I.P. rights for the finished product
You may not need this clause in your manufacturing agreement if you have a fully developed product but are only using the China factory for manufacturing it.
Ensure you include contract termination terms in case a situation arises where it is no longer feasible to continue with the contract. For instance, if the manufacturer breaches the contract, you may want to end it. However, either party can terminate the contract based on mutually agreed terms. In case your manufacturer cancels the contract suddenly without warning, it can be difficult to get compensation for any loss you incur.
It is important for you to have a contingency plan in case this happens.
The manufacturing agreement should lay down the guidelines for resolving disputes in the event they occur and their enforceability. Ensure that the contract:
the contract is written in Chinese,
the agreement includes the original registered name of the China manufacturer (the Chinese name, not the English name)
the agreement is governed by Chinese laws
a Chinese court has exclusive jurisdiction over China supplier
In case a circumvention or infringement of the contract occurs, the dispute resolution and enforceability clauses ensure you can take legal action against the defendant.
Litigation needs to occur in a court that has jurisdiction in the city where the China manufacturer's business is registered or normally conducts their business. Foreign arbitral awards in more than a hundred countries are enforced in China, which is a New York Convention on Foreign Arbitral Awards signatory. While this may work in case you are only seeking monetary damages, it will not work in all cases. For instance, if you want to bring an injunction to stop the manufacturer from making and selling your products to your competitors, the legal battle is best carried out in Chinese courts.
It is also important to include the Chinese name of the manufacturer and their Chinese business license as courts and local authorities recognize only registered Chinese names. If you put in the English translation of the Chinese name, you may not be able to take action as the courts will not recognize it.
The contract should also include a penalty clause that explains what happens if the supplier does not adhere to the manufacturing, NNN, or subcontracting terms. The exact nature of the penalty has to be stated in advance in the contract so that the manufacturer is aware of the consequences of not meeting the business terms. In case of future litigation, the agreed penalty clause can make it easier for you to claim damages. The most important value of penalty clauses in a manufacturing contract is that they prompt the manufacturer in China to comply with agreed terms.
While the penalty needs to be strong enough to ensure the China supplier takes it seriously, it should not be unreasonable that can scare them away. A reasonable penalty can be directly enforced in China courts, saving you a lot of trouble. Without the penalty clause, it can be difficult to prove the extent of loss you suffered as a result of the supplier's non-adherence to your manufacturing/NNN terms.
Additionally, the fines being agreed in advance, a lot of time is saved for the judge as well.
The manufacturing agreement with a China-based supplier will also need to have a detailed and clear dispute resolution process.
While the dispute resolution method can vary based on the type of dispute, you can specify the steps and processes you and the supplier will follow to resolve the dispute.
For instance, if your product specifications are not met or delivery deadlines are missed, the first step may be to discuss formally with the supplier. If that does not yield the desired results or is impossible, the next step is to seek arbitration and monetary damages in a court with jurisdiction.
Working with an experienced China sourcing agent benefits you in a number of ways.
Most of the challenges involved in getting your products manufactured in China can be overcome by choosing the right supplier in China. While choosing a manufacturer in China looks seemingly simple, many aspects can often be overlooked because of a lack of familiarity with the processes, language, and policies followed in China. Many times a buyer will end up communicating with a third-party contractor and not the actual manufacturer. In this case, you may not have legal recourse against the actual manufacturer.
An experienced China sourcing agency conducts thorough due diligence to make sure you work with the right supplier with a valid business license, experience, and credentials. The sourcing agency has a physical presence in China that allows them to inspect the manufacturing facility in person and conduct a quality inspection. This eliminates the hassles involved in finding the right supplier in China who has the capabilities to produce your product.
A China sourcing agency is able to connect you quickly to another reputed manufacturer in case you need to terminate your contract with your supplier. This is the best way to avoid losses and delays as a result of contract termination.
The reliable sourcing agency will also know the legal Chinese name of the business that you can include in your agreement. This ensures your contract is recognized and honored in a court in China with jurisdiction. The sourcing agency will also know if the contracting party is the manufacturer or an international sales subsidiary of a manufacturer in China. In the case of the latter, you can then ensure the Chinese manufacturer co-signs the agreement.
With comprehensive knowledge of Cantonese, Mandarin, and other local dialects, the sourcing agency helps you negotiate the best deal. They can also help you draw up a strong manufacturing agreement in Chinese that is enforceable in a Chinese court.
A reputed China sourcing agent also handles the shipping process, ensuring your products reach you on time to give you the highest return on your investment in China outsourcing.
Many business owners outsource product manufacturing to China because of the cost advantage and the advanced manufacturing capabilities many factories in China have. When you outsource to the right manufacturer, you can continue to enjoy these benefits that translate into tangible benefits. Building a long-lasting relationship with your China manufacturer is key to reaping these benefits.
Business transactions in China are based on "Guanxi" or personal rapport that helps build trust and can get you a favorable deal. Most busy foreign entrepreneurs do not have the time or resources to get to know their China suppliers and establish a rapport before signing the agreement. The China sourcing agency, on the other hand, can build a strong rapport with the best of manufacturers in China. This helps you not only get better deals but enjoy a stress-free China outsourcing experience.
Above all, the sourcing agency ensures your China manufacturer understands all the business terms of the contract, including the confidentiality agreement, manufacturing terms, subcontracting, and other clauses.