China Manufacturing Agreements: The Questions We Ask

Just was cc’ed on an email between one of our senior China lawyers and one of our more junior lawyers. The email was in response to the junior lawyer asking for “the initial questionnaire we use with our clients for whom we are drafting China manufacturing contracts.”

With a few small modifications, here is the response email from the senior China attorney:

We used to send our China manufacturing clients a very long list of questions (it had reached seven pages!). But we were finding many of them were getting overwhelmed by their heft (I don’t blame them) and no matter how much we would try to tailor them to the client’s specific situation, there were also a fairly large chunk of them that proved irrelevant. So now what we do is break up our questions into stages, starting from general matters to more specific, with the “more specific” depending on the responses we get to the general matters. By doing it this way, we end up asking far fewer questions and this in turn relieves the onus we formerly put on the client.

The first stage questions usually consist of the following:

1. Is the purchase from the actual manufacturer or is it from a trading company?
2. Who owns the technology for what is being purchased? Note that there are a number of options:
   1. IP/design is 100% owned by the foreign buyer and the Chinese side will make no modification.
   2. IP/design is owned by the foreign buyer, but the Chinese side will make some modifications.
   3. The product is an “off the shelf” item from the Chinese manufacturer.
   4. The product is based on off the shelf from the manufacturer, but is customized in some way for the foreign buyer: new colors, logo, added features.

Often the U.S. buyer will purchase a mix from the same manufacturer.

The second stage, usually involves our trying to figure out the following:

1. What is the structure of the basic business relationship?
   1. Will the parties agree on a set amount of purchases per year at a set price? or
   2. Will the parties work on a per PO arrangement?
   3. If it is per PO, what is the agreement on price, if any?
   4. If it is per PO, what is the agreement on quantity and delivery date, if any?

At the next stage, I work to figure out the following:

1. Is tooling/molding involved? If yes, what is the system?
2. Are other special materials involved? For example, in the clothing business, the buyer often purchases fabric separately and then provides this fabric to the factory.

At the next stage I work to figure out the following:

1. What is the plan for quality control and inspections?
2. What is the plan for warranty and dealing with defects that show up in the U.S. or in Europe after delivery?
3. What is the policy for late or short delivery? Some companies use the 1% a day approach and leave it at that. Other companies have an elaborate “charge-back” system where they impose a penalty for short and late delivery.

As you can see, the whole process now has become more complex than just sending out a single set of questions. Each set of issues discussed above depends in part on the answer to the previous questions. You have to go step by step, adapting your questions to the previous responses. You also have to adapt your questions to what you already know about the client and its business. If you don’t know much or anything at all, a good start is to ask the client to briefly describe their program and their history with that program and their chief concerns.

Sorry not to be able to give a quick and easy answer, but this how China contract manufacturing work has evolved.

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.