It was the best of times, it was the worst of times.
— Charles Dickens, from A Tale of Two Cities
My law firm recently got two similar calls from decent-sized US companies that do their contract manufacturing in China. Both were calling our international dispute resolution lawyers to see what remedies/leverage they might have in disputes with their Chinese product suppliers.
The first company is in a seasonal business and it was a calling because its Chinese factory demanding a substantial “premium” to deliver product “on time.” The US company was threatening the Chinese company with “just walking away and sticking the Chinese factory with the product” but further conversation revealed this made no sense at all and the Chinese factory no doubt knew this. We together determined the US company had no choice but to pay the large premium and to do things correctly in the future.
The problem the US company was facing was that it did not have a legal leg to stand on with the Chinese company and the Chinese company knew this and had made it clear to the US company that it knew this. The US company had no written contract with the Chinese company setting out clear delivery dates. The owner of the US company asked me if things would have been different had there been a contract and my response was “almost certainly yes:”
I went on to tell her the following:
Though an OEM agreement is certainly no guarantee your Chinese supplier will not come back to you seeking more money right when you really need your product, it certainly does reduce the chances of that occurring. And on top of that, if a situation like that does occur, you have real leverage to fight it. I can tell you that we have heard of this happening maybe a half a dozen times and, without exception, we hear this from companies that did not use our international manufacturing lawyers to draft their China manufacturing contracts.
Right now you have no leverage and you know it and your Chinese supplier knows it. Heck, it took me all of three minutes to realize you pretty much have no bargaining power and you really have no choice but to pay every Yuan of the requested premium and then figure out what to do the next time. If you had answered “yes” to my question as to whether you had a written OEM [original equipment manufacturing] contract, I would have asked to see it and if it had set out date requirements, I would be talking to you now about negotiating strategies, because we would have had an opportunity to employ some.
And — though there are never guarantees — I am pretty certain we would have been able eliminate or at least reduce the premium.
I then told her how we had dealt with a very similar situation for a longstanding client of ours, for whom we had written their OEM Agreeement:
Just last week, we dealt with a similar situation for a client who had an excellent OEM agreement and we stood up to the Chinese manufacturer and said that if the product did not arrive on time we would be looking to it for damages. Did the product get there on time? No. But it arrived only a week late and my client did not have to pay any premium at all. Amazingly enough, the Chinese factory owner pretty much gushed over our “knowing how to operate in China.”
For more on why written contracts are so valuable with your Chinese counter-parties check out Enforcing Contracts In China. Way, Way Better Than You Think.