Just read an article, What do Suppliers do with Rejected Products? that starts with the following nightmare scenario:
Imagine you are walking down a busy street in China full of vendors. Suddenly, you notice something: your company’s flagship product, distinctive luxury handbags, is being sold by a random merchant you have never met. Upon closer inspection, you notice several problems with the bag. These are the same bags you rejected in an earlier order from your supplier, yet here they are, still with your branding.
It then asks “what can you do to prevent this and other undesirable outcomes?” and lists out the following three measures
1. Monitor the containers leaving your factory.
2. Rework or repair defective products.
3. Destroy the rejected products and oversee their destruction.
To which I would add a forth thing: put a provision in your manufacturing agreement stating exactly what your manufacturer must do with rejected products AND a provision setting forth the amount your manufacturer must pay you if it fails to abide by this provision. See Manufacturing in China: Minimizing Your Risks by Doing Things Right.
This is THE best thing you can do to prevent the nightmare scenario described above. The international manufacturing lawyers at my law firm have been writing manufacturing contracts since the firm’s inception more than a decade ago and never once have any of our clients for whom we drafted a manufacturing contract had an issue with their manufacturer (in China or anywhere else) selling their rejected goods. But we get at least a call a month from North American, European or Australian companies wanting our help with the sort of nightmare scenario described above.
In our experience (and that of other manufacturing attorneys with whom we have discussed the issue), putting the right liquidated damages provision in your contract will prevent your rejected products showing up where you do not want them to be. A well-crafted, China-centric liquidated damages provision has this impact for the following three reasons:
- It increases the likelihood your manufacturer will abide by your contract.
- It increases the likelihood of avoiding litigation if your manufacturer breaches your contract.
- It increases the likelihood of you being able to prevail quickly in litigation if you do end up needing to sue your manufacturer.
Manufacturing companies know the strength of liquidated damages provisions and they fear them. They know if they breach a contract with a liquidated damages provision you can go to court and quickly freeze their assets for the amount of the liquidated damages provision, and still sue them for even more. And that is the last thing they want. This is what makes these provisions so effective.
Writing an effective liquidated damages provision for your China manufacturing contract is two parts art and eight parts experience. The trick is determining the right amount to assess your Chinese manufacturer in damages. You want that amount high enough to deter your manufacturer from breaching the contract and flooding the market with your rejected products, and yet low enough so that your manufacturer will sign the contract and the Chinese courts will deem the amount reasonable and enforce it. Chinese courts will invalidate or ignore a liquidated damages provision they view as too high. And manufacturers and their lawyers know this and so they will often (laughingly) go along with a way-too high liquidated damages amount, knowing no Chinese court will enforce it.
Just in case the above does not scare you enough, I have another nightmare scenario for you that comes from a company that did not have a contract with its manufacturer. This scenario went like this:
A top of the line Canadian manufacturer of a particular sporting goods product called me because it had been getting calls from consumers who had bought defective versions of their product. This company’s products sold for about $250 as compared to the $40 to $175 its competitors charged. This Canadian company’s products were (and still are) considered the best in the industry. This Canadian company had rejected approximately 5,000 of its product from its Chinese manufacturer and its Chinese manufacturer had, in turn, sold the entire 5,000 in one fell swoop to a company allegedly based in India. This “Indian” company had in turn sold all (as near as we could tell) of the defective products to someone in the United States and those products were now out on the market selling for $80.
And here’s where the problem arose: a huge number of those who had bought the product at $80 were going to our client asking it to make good on its unconditional lifetime guarantee to repair or replace its product if the consumer has any problem with it. This Canadian company wanted our advice on what to do and our advice was as follows:
Since you did not have a written contract with your Chinese manufacturer preventing it from doing what it did, suing it in China (or anywhere else) will not be worth your time or your money. You can try to get your manufacturer to pay you back for some of your damages, but it probably will not do so because you have no real legal case against it. As far as the U.S. is concerned, you can pay us a lot of money for us to figure out whether you are under a legal obligation to repair or replace the $80 items, but before you do that, I suggest you first consider whether you would be better off in the long run by treating all of these buyers as though they bought the real thing from you and just pay them. We also can try tracking down whomever it was who brought these counterfeit products (because that is what they are) into the United States and suing that person/company, but these are not usually good companies/people to sue and that is not going to do anything but publicize your existing problem, which is probably one of the last things you want.
The Canadian company ended up taking our advice and doing nothing other than giving out brand new products to everyone who complained about their $80 version. Oh, and the Chinese factory claimed not to know that what it had done was wrong (without a contract expressly forbidding such action, this was quite possibly true) and it handed over to the Canadian company half of its proceeds from its sale to the Indian company (a whopping $25,000).
Live and learn, and the learning from today is that if you want to prevent your supplier/manufacturer from selling the product you reject, you should state that clearly in your manufacturing contract with that supplier and you should have a liquidated damages provision to further nail that point home. See also Your China Factory as your Toughest Competitor, for how to prevent your manufacture from competing with you by selling your product!
