How to Avoid China Manufacturing Problems: A Primer

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China Manufacturing Problems are Increasing

Imagine investing millions of dollars into a product launch, only to receive defective or unusable goods from your Chinese manufacturer – a scenario that could cripple your business. Unfortunately, this nightmare is increasingly becoming a reality for many companies that rely on China manufacturing, without proper safeguards.

The increasingly tense geopolitical landscape, along with China’s economic slowdown, have increased the risks of manufacturing problems with Chinese manufacturers. This post aims to equip businesses with the knowledge and strategies to navigate the complexities of China manufacturing agreements to mitigate their risks and to ensure a seamless production process.

Our law firm’s international manufacturing lawyers have been seeing a big uptick in inquiries from companies encountering issues such as defective products or delayed shipments from their Chinese manufacturers. This trend reflects the broader challenges posed by increasing geopolitical tensions and China’s economic downturn.

The Solution to China Manufacturing Challenges: A Robust China-Centric Contract

Whatever the causes, having a China-specific manufacturing agreement is key to preventing problems when having your goods made in China. This post highlights what terms to prioritize in your China manufacturing agreement to avoid pitfalls from delivery delays to quality control problems.

The Importance of Having a China-Centric Manufacturing Agreement

Many of our clients who are now well-versed in China manufacturing learned the importance of detailed agreements through challenging experiences, having faced setbacks from overlooked contractual details or unforeseen manufacturing problems

We often write about the need to have a Chinese language Manufacturing Agreement with your Chinese manufacturer. In this post, we focus on what is truly important to include in that agreement, and even more importantly, the terms on which you should reach agreement with your Chinese manufacturer before you pay a lawyer to draft your agreement.

Though the simplicity of using generic manufacturing agreements or relying on verbal commitments might be appealing, the unique legal, business, and cultural landscape of China demands a specialized and meticulously drafted approach to avoid potential pitfalls. A China-specific manufacturing agreement is essential for several reasons. It addresses the nuances of China’s laws and regulations. It accounts for local business practices. It ensures that both parties clearly understand their rights and obligations. Most importantly, it gives you recourse should anything go wrong. This recourse both helps prevent problems and resolve problems that arise.

By investing in a well-drafted China-centric manufacturing agreement, you can establish a solid foundation for your manufacturing operations, while also minimizing the risk of misunderstandings and potential disputes down the line.

Beyond the legal and operational aspects, navigating the cultural differences between Western and Chinese business practices is a significant challenge. Effective communication is paramount, as misunderstandings can quickly escalate into costly conflicts. It is crucial to foster open and transparent dialogue with your Chinese manufacturing partners, ensuring that expectations are understood on both sides. Leveraging the expertise of experienced legal professionals can help you bridge the cultural and legal gaps, and facilitate a more harmonious and successful working relationship with your Chinese manufacturer. The foundation you establish with your manufacturing contract is key.

The Basic Requirements of a China-Specific Manufacturing Agreement

Contrary to popular belief, China’s legal system offers robust mechanisms for contract enforcement, outperforming not only common perceptions, but also the judicial systems of the United States, Canada, and the United Kingdom in efficiency. At least this is what the World Bank said in its last (2020) report ranking countries on their efficiency in enforcing contracts.

Yes, if you are seeking to protect your cutting-edge semiconductors based on a contract enforceable in China, your odds are not good. But if, on the other hand, you are seeking to enforce a run of the mill manufacturing contract or service contract and your contract was drafted with China in mind, you ought to be just fine.

The Five Keys to a China-Specific Contract

When drafting a manufacturing agreement in China, you should focus on the following five items to ensure that your contract is a China-specific contract that works for China.

Not having a comprehensive China-specific manufacturing agreement in place can expose you to severe risks, including:

Financial losses due to product defects, delivery delays, or non-compliance with quality standards.
Inability to seek legal recourse or compensation for damages.
Strained relationships with Chinese manufacturers, leading to potential disruptions in supply chain and production.
Reputational damage and loss of market opportunities.

1. China Dispute Resolution

Your contract with your Chinese manufacturer usually (but not always) should provide for disputes to be resolved in China, either in a Chinese court or before a China-based arbitral body, such as CIETAC.

China does not enforce most foreign court judgments, as highlighted in our post ‘China Enforces United States Judgment: This Changes Pretty Much Nothing.’ While China’s courts theoretically enforce foreign arbitral awards, the process is often complex and time-consuming. Therefore, it’s crucial to carefully consider the venue for dispute resolution.

China does not enforce most foreign court judgments, as highlighted in our post China Enforces United States Judgment: This Changes Pretty Much Nothing. Though China’s theoretically enforce foreign arbitral awards, the process is often complex and time-consuming. Therefore it’s critical to carefully consider the venue for your dispute resolution with your Chinese factory, and your best venue can depend on many things, including the nature of your contract, the situation of the Chinese company with which you are contracting, and your biggest risks.

2. Chinese as the Official Language

Designating Chinese as the official language of your contracts is not just a legal formality; it’s a strategic move that helps to ensure clarity as between you and your Chinese manufacturer, along with legal precision and enforceability in China’s judicial system.

If your contract will be in Chinese, your lawyer must fully understand the Chinese in your contract and China’s byzantine IP and manufacturing laws. They also should be fully capable of translating that contract into written English for you. Most of the contracts my law firm drafts with China are in both Chinese and in English, but with Chinese as the one official language of the contract. See Dual Language China Contracts: Don’t Get Fooled!

3. China Law as the Applicable Law

Your contract with Chinese companies typically should call for application of Chinese law. If your contract is in Chinese and your disputes will be resolved by a Chinese trier of fact, this only makes sense. Chinese laws on manufacturing do differ from those of the United States and the EU, but if you know what they are, it is relatively easy to contract in a way that protects your business.

One example I always cite is how there are no laws stopping your own manufacturer from duplicating YOUR product and selling it to ten other companies for 25% less than they are selling YOUR product to you. But, if your manufacturing agreement with your Chinese manufacturer prohibits this, your manufacturer selling your product to others will constitute a breach of contract for which you can collect damages. And if your contract also contains a commercially reasonable damages provision setting out what your Chinese manufacturer must pay you if it does sell your product to anyone else, the odds of your manufacturer selling your product to someone else just went way down.

4. Explicit Contract Damages

You usually should have a provision calling for contract damages. This provision can act as a heavy hammer against your Chinese counterparts. See China Contract Damages Done Right.

5. The Correct Chinese Company Name

Make certain the name (in Chinese) of your Chinese counterpart is 100% accurate and corresponds with its official company name. And while you are at it, it is also good to have your Chinese counterpart stamp/seal the contract as well. See China Company Chops: The Basics.

Fundamental Issues in China Manufacturing Agreements

When drafting a manufacturing agreement in China, you should focus on the following five key issues:

Price
Quantity
Delivery date
Quality
Payment terms

Many manufacturing companies in China are small, privately owned businesses with limited funding, often using basic operational methods. It is not uncommon for a Chinese factory owner to tell us that since they gave our client “the China price,” and since that price is so low, it should not be required to care about the other four issues listed above — quantities, delivery dates, quality, and payment terms. When working with any China manufacturing company, you should make clear that all five of the fundamental manufacturing issues are critical, not just price. Only after you have resolved this with your Chinese factory should you move on to other more complex issues.

The below are some of the typical pitfalls our China manufacturing lawyers see companies make when negotiating price, quantity, delivery date, quality, and payment terms, with their Chinese manufacturer:

1. Price

The product buyer negotiates a specific price list with its manufacturer, but the manufacturing agreement is written so that the Chinese manufacturer is not obligated to accept all purchase orders. So as soon as the agreed upon pricing works against the Chinese manufacturer, the Chinese manufacturer simply refuses to accept the purchase order and insists on a substantial price increase. When this happens in the middle of a sales season, it can destroy the product buyer’s business of the buyer. Our China attorneys get calls on this every year, not so coincidentally, especially as Christmas approaches.

2. Quantity

If your contract with your Chinese manufacturer does not include a penalty against your manufacturer for a short delivery, your manufacturer can make short deliveries with impunity, and they often do, especially if they have a new customer paying more for the same product. The best way to prevent short deliveries is to provide a penalty for short deliveries in your manufacturing contract, and to regularly monitor the production process in the Chinese factory.

3. Delivery Date

Many Chinese manufacturers view delivery dates on purchase orders as guidance, not a strict date. So long as the Chinese manufacturer delivers within two to three months of the delivery date, it feels it is doing just fine. This can of course be a disaster for the product buyer who has made delivery date promises to its own customers. The most common situation is a buyer purchasing for the holiday season. The delivery date is September 15, and the Chinese factory delivers on December 15. The Chinese factory says, “we were only three months late, what’s the problem?”

We had this situation once with a Christmas tree light company that contacted us in October after learning it would not be getting its two-million-dollar Christmas tree light order until December. Late deliveries can be particularly bad for foreign buyers who are feeding their product into a “just in time” inventory system. Late delivery means the whole system is affected, often subjecting the foreign buyer to crippling penalties.

A contract that is clear on the importance of delivery dates and has a damages/penalty provision to back it up, will greatly increase the odds of getting timely deliveries.

4. Quality

Quality problems from Chinese factories are well known. The below are just a tiny sample of the kinds of problems our China manufacturing lawyers have handled for product buying companies that retained us (for the first time) after problems arose:

a. Staples for an automatic nail gun. The staples were beautiful, except they did not fit into the product buyer’s nail gun.

b. Hand blown Christmas tree ornaments. A whole container arrived and on time. The objects were beautiful. The only problem was that the small ring required to hang the ornament from a tree was missing, making the entire shipment useless to the product buyer.

c. Etched glass fixtures installed between two sheets of glass in an argon filled custom window. Everything about the window was perfect, except that when installed, handprints were obvious on the etched glass, rendering the windows worthless.

d. Custom door handles. The handles were well made and worked perfectly. However, the surface coating on about half of the handles was flawed. This required the buyer to open every custom package to individually inspect each item.

All of the above buyers made the same mistakes. They all failed to put clear quality requirements into their manufacturing contract, along with clear penalties to be assessed (liquidated damages) against the manufacturer for failing to meet quality benchmarks. They also failed to conduct an initial inspection of their products in China, and they made full payment before conducting a secondary inspection upon arrival of the products in their home countries.

5. Payment Terms

The standard system in China for OEM manufacturing is for the Chinese manufacturer to require a 30% to 70% down payment with the remaining 30% to 70% due on shipment. Most U.S. and European product buyers then wait until the product arrives in their country before they do their inspection. This means that when the product buyer discovers a product problem, its Chinese manufacturer has already been paid in full, so it has little to no incentive to deal with the issue, and they rarely do. Instead, they will mostly just stall and stall and stall.

Though it is possible to litigate in China to resolve these issues (assuming you have done everything right with your China OEM Agreement to allow for this), Chinese factories understand that the total value of any single container of goods seldom justifies the cost of international litigation, so they tend not to care. The best way to prevent these sorts of problems is to have your China-specific manufacturing contract clearly outline this process, and give you clear recourse should anything go wrong.

A Seven Step Plan for Drafting a China-Specific Manufacturing Agreement

Navigating the complexities of international manufacturing, particularly in China, requires planning and legal foresight. Drafting a China-specific manufacturing agreement is a crucial step towards establishing a secure and productive relationship with your Chinese manufacturer. The following seven-step plan outlines the essential stages involved in creating a manufacturing agreement tailored to China’s unique challenges and legal landscape.

This structured approach will ensure is intended to ensure that your manufacturing agreement is comprehensive, legally enforceable, and aligned with both your business objectives and the regulatory environment in China.

Step 1: Initial Consultation

Identify your manufacturing needs and goals.
Consult with legal counsel experienced in Chinese manufacturing agreements.

Step 2: Choose the Right Manufacturer

Conduct due diligence on potential manufacturers. For what this typically entails, check out The Essential Role of China Due Diligence.
Discuss with your potential manufacturers your specific requirements to gauge capability and willingness to comply.

Step 3: Negotiate Key Terms with your Potential Manufacturer

Get at least general agreement on price, quantity, delivery dates, quality standards, and payment terms.
Discuss dispute resolution preferences, contract language, and applicable law.

Step 4: Draft the Manufacturing Agreement

Obtain the correct Chinese company name and have the contract stamped/sealed by the manufacturer.
Have your experienced China manufacturing lawyers draft your contract — usually in Chinese as the official language and an English translation for your review.
Include detailed specifications and requirements for product, quality control measures, penalties for non-compliance, and explicit contract damages.

Step 5: Review & Negotiation of the Manufacturing Contract

Review the draft with your legal counsel and negotiate any necessary revisions with your potential manufacturer.

Step 6: Finalize & Execute the Manufacturing Contract

Both parties sign and stamp/seal the contract.

Step 7: Ongoing Monitoring & Quality Control (post contract)

Conduct regular audits and inspections to ensure compliance.
Maintain open communication with your manufacturer as this aids in resolving issues that might arise.

Real-World Insights: Case Studies on China Manufacturing Agreements.

The following two case studies starkly illustrate the critical difference a well-crafted, China-specific manufacturing agreement can make, highlighting both the pitfalls of oversight and the benefits of diligence. These real-world scenarios underscore the potential consequences of neglecting formal contracts with your Chinese manufacturers and highlight how comprehensive China-centric manufacturing agreements can safeguard your business interests and ensure successful manufacturing outcomes.

Case Study 1: A Negative Outcome Due to Lack of Proper Contract

Background: A mid-sized European electronics used Purchase Orders (POs) and Invoices to buy a new range of smart home devices from its longstanding Chinese manufacturer. Neither the POs nor the Invoices made any mention of product quality or delivery timelines. The European company was relying entirely on oral assurances of quality and timelines.

Problem: Upon receiving the first shipment, the European company discovered that a large number of the products failed to meet the orally agreed-upon product specifications. Worse, the entire shipment arrived three months late, causing the European company to miss out on the critical holiday sales window. The Chinese manufacturer, citing misunderstandings about specifications and timelines, refused to take responsibility. This company contacted my law firm’s international dispute resolution team to see about securing recourse from the Chinese manufacturer that did it wrong.

Outcome: Though the European company was facing substantial financial losses from unsold inventory and missed market opportunities, our law firm chose not to take on the case against the Chinese manufacturer because without a detailed contract specifying quality standards, delivery dates, and recourse for non-compliance, we felt that the European company had little leverage to negotiate compensation or secure corrective action from the Chinese manufacturer.

Case Study 2: A Positive Outcome with a Well-Drafted Contract

Background: An American home goods company had my law firm’s China manufacturing lawyers draft it China-specific manufacturing agreements with all dozen or so of its China suppliers. Their contract included the following:

Dispute Resolution: Specified disputes would be resolved in China via CIETAC arbitration.
Language: Designated Chinese as the official language of the contract.
Quality Control: Included detailed quality specifications and liquidated damages for non-compliance.
Delivery Timelines: Defined strict delivery dates with a liquidated damages clause for delays.

Outcome: Midway through production, a quality audit revealed deviations from the material specifications. Citing the contract, the American brand was able to promptly negotiate a resolution with the manufacturer, who corrected the issue at its own expense to avoid damages. The subsequent “make-up” shipment met all specifications and arrived on schedule, and soon enough so that our client was able to meet (or nearly meet) all of its downstream deadlines.

Conclusion

To ensure the security and success of your manufacturing operations in China, proactively addressing the essential elements of pricing, quantity, delivery schedules, product quality, and payment terms in your contractual agreements is paramount. You should ensure that your agreements are not just verbal, but are captured in a legally binding, China-centric manufacturing contract that fully protects your interests.

Be sure to conduct thorough quality inspections in China before making significant payments to your suppliers. Withhold your final payment. For more on what it takes to succeed when having your manufacturing done in China, check out Manufacturing in China: Minimizing Your Risks by Doing Things Right.

This approach to drafting a manufacturing agreement and the outlined safeguards help mitigate the common risks associated with manufacturing in China, providing a solid foundation for successful international partnerships.