China Contract Manufacturing Agreements: Watching the Sausage Get Made

When our China lawyers provide the first draft of a contract to a client, we typically explain a bit about why we did what we did in the contract. The below email is an amalgamation of various emails from our China manufacturing lawyers explaining their first draft of a China Contract Manufacturing Agreement. I am providing this here because it nicely highlights the sort of things that should go into a China Contract Manufacturing Agreement, along with how Chinese factories typically react to various proposed provisions.

Please find attached a first draft in English of a Contract Manufacturing Agreement for China. Please review and provide us with your comments and revisions. After we agree on a final English language version, our legal team will translate this into Chinese.

Please note the following with this Agreement:

1. Your company has a long history working in China and it has procedures it has established for its China manufacturing. If this Agreement needs to be revised to better accord with your company’s existing procedures, please provide us with specific instructions on this and we will make whatever changes are necessary.

2. The basic idea with this CM Agreement is for it to become your company’s standard main agreement that it will use with all of its factories in China. For that reason, our strategy is to include in the agreement only matters that you will expect will never change. Matters that may vary from factory to factory and from time to time with any individual factory have been moved to exhibits or to separate documents that you will provide to the factory. We worked to strike a balance on this issue. However, if there are matters you believe will never change and that we did not include in the CM Agreement draft, let us know and we will include those provisions in this document.

3. Note that this contract manufacturing agreement is limited in scope as follows:

a. It applies only to the PRC. It does not apply to HK, Macao or Taiwan.

b. It applies only to purchases you make  directly from the factory. For purchases from a sourcing agent or broker, you will need a different type of agreement.

4. Please also consider the following matters related to this document:

a. The factory is not permitted to sell your Buyer designed product to anyone but you. The same applies to Custom Product. We have not provided for any restrictions on their selling the factory Base Product into your market. If you want the factory to be restricted in selling its Base Product we can include such a provision, but I note that most Chinese factories strongly resisted restrictions on sale of their Base Product except in cases where the Buyer agrees to purchase large quantities of product within the time period where the restriction applies.

b.  We provided for a very general system for projections. If you want to provide for more specific detail, please provide and we will include.

c. We left a lot to go into the price list so as to provide you with maximum flexibility. However, if there are price provisions you will always require, we can insert those provisions into the main agreement. For example, you may always require one or more of the following:

• Price quoted as FCA Named Port, and FCA (NOT FOB) Incoterms will apply.
• You may provide for very specific payment terms. Terms in China vary widely from Net 90 after acceptance (most favorable to the buyer) to 30% down and 70% prior to shipment (most favorable to the factory). If you have a standard you want to hold to, it should be included in the CM Agreement. However, most U.S. companies we work with do not have a standard.
• If you want to provide specific rules regarding price locks and price adjustments due to exchange rate fluctuation you will need to develop a specific rule that will then be included in the CM Agreement. As you know, Chinese factories are accustomed to manipulating price lock mechanisms and they are accustomed to pushing the exchange rate risk onto the buyer. Fair and normal procedures in this area may receive push back from Chinese factories.

5. It has become customary to require a chopped purchase invoice from the factory to ensure the factory is locked down to specific terms. It is your call on whether you want to use this procedure. Some buyers have a policy of working with purchase orders that are signed and chopped by both the factory and the buyer.

6. This QC section is very general. Many buyers have a QC manual or other formal procedure they require the factory to follow. If you have such a manual, we should reference it in the Agreement and include it either as an exhibit to the Agreement or as a document you will provide to the factory separately. We will need to be clear enough about the name of the QC manual so we are sure it is clear what document is intended. These QC manuals are complex, they change over time and they often vary from product to product and from factory to factory. For that reason, it is usually not practical to include the terms in the main CM agreement.

7. We have included a very general reference to molds and tooling. We have a standard set of provisions for mold ownership and transfer, but it generally only works where the buyer pays for the molds in full. Your system is different, so we have limited the provision to this general reference. As you know, mold disputes are common in the China contracting world, so some attention to this issue is required. I suggest you read Manufacturing in China: Control your Molds (Part 1), Manufacturing in China: Control your Molds (Part 2), and Manufacturing in China: Control your Molds (Part 3).

8. We have provided that the factory will comply with U.S. law for Base Product/Custom Product since the factory is in control of the specifications for such product. For your own buyer designed product, you will be providing the specifications. If compliance with U.S. regulations is required, the specifications will deal with that issue. The big issue with U.S. regulations for product that you design yourself is what entity will take the lead in obtaining approval and what entity will bear the cost of approval. This is a complex and contentious issue normally addressed in a separate agreement relating to the specific product. If you want to deal with this issue in general terms in the CM agreement, please indicate the standard you wish to impose.

9. Some buyers require their Chinese factories to comply with policies imposed by the buyer. These include:

a. Compliance with U.S. and Chinese anti-bribery laws.

b. Treatment of workers and related labor conditions.

If you have specific policies with which you will require the factory comply, please specify and provide us with a copy. In general terms, it is assumed the Chinese factory will operate in compliance with Chinese law related to anti-bribery, payment of taxes, payment of wages and compliance with Chinese labor conditions regulations. It is therefore only required that you make a specific statement here if you are requiring the factory adhere to a standard higher than what is provided by Chinese law or that is imposed by U.S. law.

I look forward to hearing from you soon on this matter.

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.