Webster’s Dictionary defines indemnification as “to make compensation for incurred hurt, loss, or damage” and our clients often request indemnity to protect against a product that injures people or infringes on some third party’s intellectual property right. Seeking such indemnification makes complete sense because the last thing you want when you buy $250,000 of some product is to find your own company on the wrong end of a massive lawsuit for personal injuries or patent infringement. If you are going to have a product manufactured for you in the United States or in the European Union, you commonly include one or more indemnification provisions. In addition, it also usually makes sense to require your manufacturer have enough insurance to be able to pay you on any indemnification claim.
Less so when buying products from China.
The issue of products liability insurance is significant for China, yet in our standard manufacturing agreements with Chinese companies we typically do do not reference insurance. The reason for this is because products liability insurance that would cover U.S. or European based products liability/government recall claims is generally not available in China. Most Chinese factories carry no insurance at all for this type of claim. This lack of insurance is a reason for the “China price.” For entities that want to be covered by insurance for U.S. or European based products liability claims, the best solution is usually to purchase such insurance from a U.S. or a European insurer. The cost of such insurance then illustrates why the China price is often not as low as it seems.
Some of our clients insist on including a standard U.S. or European style insurance provision in their manufacturing contracts with Chinese factories. This usually elicits one of the following three responses from the Chinese manufacturer:
1. The honest Chinese factories usually refuse to agree to this requirement/provision because they know they probably will not be able to secure this insurance.
2. Some Chinese factories agree to sign but then also state that they will raise the price of their product(s) to account for the added cost of the insurance. In this case, what they usually mean is that they will purchase the insurance from a U.S. or European insurance company and they will pass on the price of the premium to the U.S. or European buyer.
3. Some factories will sign but then not obtain the insurance.
We have seen Chinese companies provide fake policies to try to trick Western companies into believing they have insurance. If it is going to cost you the same amount to have your Chinese manufacturer secure sufficient insurance coverage to protect you, but you run the added risk of being tricked about the existence of the coverage, you really do need to ask whether this request even makes sense.
And here’s another thing to consider if you think you are going to be protected by your indemnification provision and/or your Chinese counterpart having secured insurance for you. With China cracking down so hard on hard capital leaving the country (See Getting Money Out of China, Part 6 and the five posts that proceeded that), there is a good chance that even if there is someone in China wants to pay you in the United States or in Europe they will be unable to do so.
In a more general way, one of the risks you will face in getting your products from Chinese manufacturers is that Chinese tend to be either underinsured or not insured at all. This imposes significant risks most U.S and European buyers do not take into account. For example, say you pay a 30% deposit/prepayment for your products and then the factory burns down, and your work in progress is lost. In this case, it would be very rare in China for the factory to have insurance that would cover you for this loss. Say you make the mistake of purchasing your product on FOB terms. In this case, your shipping insurance does not cover the product until after it is loaded on the ship. Say the product is lost in a vehicle accident on the way to the port or in an explosion at the port. Again, it is unlikely the Chinese factory will have insurance covering the situation and once again your deposit is lost. In the U.S. or in Europe, the odds are great these sorts of things would be covered by an appropriate insurance provision, naming your company as an additional insured, but this type of insurance is generally not available in China. So the only way to cover the risk is to purchase your own insurance, which again raises the actual cost of purchasing from China. Most smaller companies either do not understand the risks they take or they take the risk intentionally. In either case, they are underestimating the true cost of purchasing products from China.
As you can see, these various insurance/indemnification issue are quite difficult for China and there are no easy answers.
What do you do to minimize these China risks?