How to Prevent your Manufacturer from Selling Your Rejected Products

Just read a long and very good article entitled, What do Suppliers do with Rejected Products? The post starts out with the following nightmare scenario:

Imagine that you’re 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’ve never met. Upon closer inspection, you notice there are 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 four 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 most emphatically add a forth thing: put in your manufacturing agreement a provision stating exactly what your  manufacturer must do with rejected products AND a provision setting forth the amount your manufacturer must pay to you for failing to abide by this provision. This is by far 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 ever had an issue with their manufacturer (in China or anywhere else in the world) 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), your putting the right liquidated damages provision in your contract does the following important three things generally and specifically for preventing against your rejected products showing up where you do not want them to be: :

  1. Increases the likelihood your manufacturer will abide by your contract.
  2. Increases the likelihood of your being able to avoid litigation if your manufacturer breaches your contract.
  3. Increases the likelihood of your 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 shockingly 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, when done right.

Writing an effective liquidated damages provision for your manufacturing contract is two parts art and eight parts experience. The trick is determining the right amount to assess the 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 you also want it to be low enough so that your manufacturer will actually sign the contract and with an amount a court will actually deem reasonable and enforce. 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 court will ever enforce it.

Want to prevent your manufacturer from selling your rejected products? Use a manufacturing agreement that will prevent that.

Oh, and just in case the above does not scare you enough, I have another nightmare scenario for you, one that comes from a phone call I got a few years ago from a company that did not have a contract with its manufacturer. It went something like this:

A top of the line Canadian manufacturer of a particular sporting goods product called because it had been getting a slew of 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. We are talking the true top of the line. 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 U.S. and they were now out on the market 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 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 it to pay you back for some of the damages you have sustained, but it probably will not do so (because you have no real legal case against it) unless it deems doing so to be in its own business interests so as to be able to keep manufacturing for you. 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, you should consider whether it might not just be in the best long term interest of your company to treat 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 has to be 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 manufacturing nightmare from competing with you by selling your exact same product!