China Factory Indemnification: Yeah, Whatever

American and European lawyers love indemnification provisions in product manufacturing agreements. They love them so much they often use them in China manufacturing contracts (OEM Agreements) even though they do not work well there.

American and European lawyers will put in a provision stating that if a product defect leads to a recall or injures anyone, the Chinese manufacturing company must indemnify the American/European company for any fees/costs/damages incurred by the American/European company caused by the defective product/recall.

These sorts of provisions sound really good, but they usually aren’t.

If a Chinese manufacturing company breaches a contract in a way that damages the American/European buyer, the Chinese side is legally liable for the damages that flow directly from such a breach, including the damages set out in a typical manufacturer’s indemnity provision. It is therefore usually unnecessary to include indemnity provisions in contracts that will be enforced in China under Chinese law. For why it usually makes sense to have your manufacturing contract be enforced in China, check out China OEM Agreements. Why Ours Are In Chinese, Flat Out.

American/European companies are quite reasonably concerned that if their Chinese manufacturer provides them with defective products they (the American/European companies) could incur damages in amounts much greater than the purchase price of their product. In that situation, a claim against the Chinese manufacturer for a refund of the product price or a repair or replacement of the products is not going to come close to covering the American/European company for the damages it incurs. This is very real risk in purchasing products from China.

The problem though is that you cannot expect to get a Chinese court to find a Chinese company liable for such damages — certainly not to their full extent. Foreign judges generally — and Chinese judges in particular — think American courts are out of control with the damages they impose in product liability cases. So even when a Chinese manufacturer has clearly breached its contract (lead paint in children’s toys for example), Chinese courts and Chinese arbitrators typically will limit the damage award to nothing more than the direct costs: a refund, a repair or a replacement, plus maybe reimbursement of penalties imposed against the American/European company for something like a late delivery. Chinese courts and Chinese arbitrators almost never enter judgments or awards that will fully cover the losses an American/European company might suffer from product liability claims, whether made by consumers or by a government. This is true both with and without a contract with an indemnification provision.

Usually, the best way to protect your company from product liability and product recall damages is by securing the right insurance, with the premium costs of this insurance viewed as part of the cost of you doing business with China. You can try to get your Chinese manufacturer to pay your insurance premiums, but in our experience few Chinese manufacturers will agree to this and those that do will either raise their product pricing or — even worse — lower their product quality to cover it.

The same holds true for mandating that your Chinese manufacturer secure its own product liability insurance, only worse. In this sort of situation, you will need to retain a lawyer to review the Chinese insurance policy that purports to provide your Chinese manufacturer with liability protection and you will also need to make sure that it lists your company as a beneficiary to the policy. Then, if you do ever have a claim on the policy, you will need to work with or sue the Chinese insurance company to get it to pay for the damages your company incurred.

Sorry, indemnification lovers. . . .