Sourcing Product Manufacturing: A Tale of Two Companies.

International Manufacturing Lawyers to protect your manufacturing molds

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.

6 responses to “Sourcing Product Manufacturing: A Tale of Two Companies.”

  1. Great Dickens quote, short and sweet. It aptly accentuates the current situation in China.
    Also, an equally nice and brief anecdote. Without prying too much into the details (I hope), was this a first-time experience for Company 1 dealing with Chinese manufacturers? Or was there any indication that the manufacturer would play such a hand?
    Thanks.

  2. Yes, OEM contract is very important.
    It’s in writing.
    There is no need to debate Confucius theory.
    “Confucius did not believe any one person was the possessor of the truth. He believed that through rational discussion the truth could be worked out between two people, and that the truth often was found somewhere between the two positions.”
    In the instance of a contract there are no distinct “two positions”.
    Hence the Chinese will abide by the written word.

  3. Why did that first company not sign a written contract? From the outside it certainly looks like a really bad idea

  4. Nothing like real life examples to make a point clear.
    I’ve just recommended all your posts about OEM in my entrepreneurs’ blog, as part of the series on how to deal with suppliers. I think they are really insightful.

  5. well, foreign companies dealing with China must have a contract and must have a well-written contract.
    A US company approached me recently for advice on its ongoing dispute with a Shanghai company in relation to their contract under which the US company helped the Chinese company to develop international market for the latter’s products.
    After several years of efforts, upon seeing the dawn of success, the Chinese company terminated the coorporation, leaving the US companies with an arbitration to recover its losses in CIETAC.
    What I was surprised is that the contract was so simple that it had poorly three pages in light of their long-term coorporation (four years). It will be right to say that the longer the contract is, the better you are protected in international transactions.
    What downed me most about the contract is that it simply provided no default liabilities clauses, which left the recovery for losses difficult under Chinese laws since it was generally hard for the non-breaching party to calculate their actual loss, direct and consequential.

  6. I did marketing work as an independent contractor/company for a large, U.S. company. They sold a product on line and wholesale. Eight years. Sold that business at the end of ’08 and travelled to China on their behalf, (at my expense) to source several products for them. I did this. Returned again, to “hand shake” with our supplier factories in two different cities of China. I have since worked directly with the Owner of this U.S. company, spending thousands of hours on skype, sourcing new products for them. They are in the process of adding their third Web Site, for the items I have sourced. I do the buys, send them my company invoice and TT/wire transfer money for each individual buy.
    This U.S. company is now “squeezing” me out of the picture and has gone so far as to ask for my introductions to the China Suppliers. They know who they are, but I feel they are covering their ass to make this look as those I have stepped aside.
    Anyone know what my real rights are? This was all word of mouth with the U.S. company owner. I have almost three years into this. I feel they think I am making to much and are trying to get me out.

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