China Manufacturing Template Agreements

Our law firm does not do template manufacturing contracts for China, or for anywhere else for that matter. Never have and never will. See China Contract Templates for $99 Each. We have many reasons for refusing to do such agreements, but the main reason is that we have never seen a China manufacturing template that worked nor do we believe that we can ourselves create one.

I thought about that today after reviewing an email from one of our international manufacturing lawyers to a client on which I was cc’ed. The email was the third or fourth email between this lawyer and this client regarding the client’s manufacturing agreements, and yet our manufacturing lawyer was still trying to get more information and clarity from the client before beginning work on the initial draft of the Contract Manufacturing Agreement the client wanted.

I repeat: the initial draft version. In other words, once this lawyer gets the answers sought, the next step will be to generate an initial draft and then the client will review that and then this lawyer will generate another draft of what may be the final version. After that, one of our lawyers will then take the English language version and write it in Chinese.

I defy anyone to read the above and the below and then contend that an off the shelf, one-size fits (or usually doesn’t) Contract Manufacturing has any value at all. The below is the email, modified a bit to hide any client identifiers.

The following is what remains open for the draft CM [Contract Manufacturing] Agreement:

Section 1.3: Do you actually own the entire product design? It seems more likely that you own your logo and your trademark, and your packaging and the customization of your _________ product. On the other hand, the factory owns the process/IP in the _____ product. This is normal in the CM world. Since ownership of design and IP is critical for this product, this section should be carefully drafted to reflect the situation on the ground so please advise me on this.

Section 1.5: You should note that this provision does not require the Chinese factories to accept your Purchase Order. This means that these factories can “bail out” at any time by simply refusing to accept your PO. More specifically, it means that the one-year price lock that you requested is nearly meaningless because the factory can raise the price simply by refusing to accept your purchase order at the old price. This is all quite normal, but please ensure that this “per Purchase Order” approach is what you want.

Article 2: As noted above, a one-year lock on price is not effective if the factory has the contractual right to refuse to accept your purchase orders during the price lock period. If you do all your orders in one year lots, this will not be an issue.

Section 3.2: Pursuant to INCOTERMS, Free Carrier is the preferred term. This is critical for issues relating to transfer of title and insurance.

Section 3.3: There is no explicit statement of payment terms, which means this will be dealt with in the Purchase Orders. This is normal, since you will very likely vary payment terms from time to time with these factories and you will also no doubt vary payment terms from factory to factory. Note that payment terms is a critical issue. In particular, the timing of your payment vus a vis the inspection procedure is important. The general rule for China is that you should not pay the final amount for your products until after you have personally inspected the product. Right now you are providing for inspection upon receipt in the United States. This means that if you have already made full payment before your inspection, you will have little to no bargaining power over your Chinese manufacturer if you get bad product, your only relatively easy remedy will likely be just a credit against your future purchases, which will essentially trap you into making purchases from a factory you know makes defective product.

Section 3.4(c): 7 days marked in yellow: this requires your approval.

Section 3.5: This section imposes a stiff penalty of up to 30% of the invoice price for late shipments. This is normal. I note, however, that your Chinese factories are already complaining about storage costs, so we have to be mindful of how will they respond to storage costs plus a late delivery penalty. I suggest we see what they say.

Article 5: You are providing for a standard AQL inspection/defect system. This is the current best practice. However, note that you should specify the criteria for each level of defect and the remedy for each level of defect as well. It is common in AQL systems for the remedy for the remedy for each level of defect to be neglected, which then renders the system without value. For your AQL system, you can either specify the entire system in the agreement, or we can create a separate document that sets out the full system. The separate document can be attached as an exhibit or referenced as a separate document that you will provide to the factory. My comments below will be based on this.

Section 6.1: The number of days you have for product inspection should be specified.

Section 6.2: The full AQL process must be stated. As the draft notes, the draft language is a placeholder for your consideration andit is not complete. The standard trigger points for acceptance of the defect levels [for this particular product!] is as follows: Critical defects, 0%; Major defects, 2.5%; Minor defects, 4%. These percentages are not fixed and may be adjusted based on the product. The real issue is what will be done when you find defects beyond the acceptable level. This can be complex. For example, what do you do if the ENTIRE shipment shows minor defects, which is a relatively common occurrence.

Section 6.3 (c): This is placeholder language and it requires your review and confirmation.

Article 7: This means the factory owns the tooling and it can use that tooling for any purpose and without any obligation to provide tooling to you after termination of the agreement. Please confirm this is indeed your intent. This is an important issue because this provision then conflicts with Section 1.2, to the extent the tooling is customized to manufacture your proprietary product for which you own all IP. Normally tooling is part of that IP. If this is not an issue, then the current language is acceptable.

Article 8: The general warranty provision must be coordinated with the AQL system and for that we will first need to resolve what constitutes a defect that triggers the warranty. Is the warranty applicable only to critical defects or does it apply to all defects in the AQL system? The easiest way to deal with this is to limit the warranty to critical defects. This applies to both the general warranty and the epidemic failure sections.

Section 8.1: The length of the warranty period needs to be confirmed. One year is normal for most of your products, but other warranty periods should probably be different, depending on the specific product.

Section 8.2: What constitutes “epidemic failure” need to be defined and we should talk about that.

Section 9.1: The Initial term must be specified.

Please advise on the above and we can revise to reach a final draft. The final draft will then be translated by our team.

What are you seeing out there?