After months of research and vetting, you’ve finally chosen a trustworthy contract injection molding manufacturer (CM) in China which offers the highest quality and value combination and has a good track record, and now it’s time to seal the relationship with an agreement for supply. Because of outsourcing and globalization, a lot of CMs in China today are large and sophisticated, however, a lot of them prefer to utilize supply agreements that appear like inept purchase orders. It is possible that they are doing this to cut time but frequently they do this deliberately to ensure that buyers don’t receive the protections they need. You should resist the temptation to get the CM immediately to sign on with an insufficient supply agreement and leave many important issues unresolved. A lot of companies have made this mistake by the way.
A solid supply contract should include a complete list of business requirements for the buyer and CM and also the legal recourse that buyers have against CM in the event of a breach. Below are six practical ideas on some of these “must-haves” in supply agreements with Chinese CMs.
Make Sure you Sign with the Correct Party
You should sign a contract with a company that has enough financial resources in case things go wrong. This seemingly simple principle is often ignored since a lot of buyers contract with third-party sourcing companies that are not affiliated with the CM that controls the factory. If a defect in the product is discovered, the buyer can only pursue legal action against the contracting party and not the actual CM. The contracting party may be the holding company for the CM in Hong Kong, Taiwan, or Singapore. You should do the necessary research and make sure that the company you’re paying isn’t a shell entity that has no to no capital. If the contracting party is a foreign sales division of a Chinese CM it is recommended that you think about getting the Chinese CM to co-sign the supply agreement or guarantee the execution of the supply agreement. It is important to note that many Chinese firms do not have an official English name and thus should be identified with your legal address in Chinese in conjunction with their English name on the supply agreement.
Include a Detailed Bill of Materials as well as Pricing and other Provisions
A Bill of Materials (BOM) is a list of components to be used in the fabrication of the product. Including a precise BOM as part of your supply agreement is a must in the event that you intend to rely on the CM to source raw materials and other components for the product. This will help prevent the CM from using less expensive materials at their discretion and will reduce product defects and recalls.
When you have worked out the unit cost to pay to CM and you think about the inclusion of specific pricing requirements in the supply agreement. CMs are not going to be shy about revealing the rising cost of labor and inflation within a few months of signing the contract and requesting a price adjustment.
If you want to have fixed prices for the following two years, a volume discount, or a specific cost reduction plan, or if you wish to define the pricing model that is based upon the BOM or other pricing adjustment mechanism, be sure to include relevant clauses in the supply agreement or an accompanying pricing document. If you are planning to sell certain items in China and the Chinese market, you’ll require separate pricing rules for exports as well as products that are marketed that are intended for the China market because of the effects of VAT and title transfer rules.
Define the Quality Requirements and Product Warranty
You must include detailed product (and packaging) specifications, as well as the procedures for quality control and inspection as part of the agreement for supply. It’s common to have an inspection both before and after the delivery of the product and this is crucial if the ultimate delivery destination is far from the Chinese manufacturing center. Think about the nature of an inspection–every product vs. sampling, parameters for an outbreak of failure, etc.–and look to tie payments to CM with the results of the inspection.
In the past, CMs in China were insistent on a lack of warranty. Today, more CMs are willing to provide product warranties against product defects which are the responsibility of the CMs are responsible–i.e., design defects for which the buyer is responsible. However, you are not covered and should certainly consider requesting one. The warranty duration is typically calculated from the date of shipment since it is difficult for CMs to know the date of purchase.
Be Sure to know who is the Owner of the Mold/Tooling
There’s no shortage of stories of horror about mold and tools disputes with Chinese CMs. The CMs know that without tools or molds the CM or you CM cannot immediately make the items and can utilize the molds/tooling to make you in a bind. Make sure you get the CM to sign a contract of supply that you hold the mold/tooling in all instances and include a thorough mold/tooling list. If you’re transferring existing molds/tooling to the CMs request a deposit and specify what amount is required in your supply agreement. Also, think about including an obligation to pay liquidated damages that provides a predetermined amount of damages if your tooling or mold isn’t returned to you on time when you request. Reasonable liquidated damage will put you in a strong position to obtain a swift judgment from a Chinese court. This also provides the Chinese court a reason to place a freeze on the CM’s assets before you secure a judgment which will almost always lead to the return of your tooling and molds.
Protect Your Intellectual Property
You may already have registered your trademarks, patents, or copyrights on your primary markets, as well as in China. These registrations could prevent the export of counterfeit products from China, and prevent an opponent from registering identical intellectual property in China. In the event that it is your core IP is know-how and trade secrets that can’t be protected through formal registration, the CM must agree in the supply contract that you have the know-how and trade secrets, and also any intellectual property rights you acquire such as any new know-how or trade secrets, which originate in connection with the production of your products in accordance with the supply agreement. Indicate clearly whether the CM may work for any other customers in the same field (and the length of the non-compete time) and, if so it is the case, how the production teams and lines will be divided. Be sure to take care to address any potential product “leakage” problem, including disposal of defective goods. IP protection is a different area where a liquidated damages provision can be useful.
Make Sure you are Knowledgeable About Dispute Resolution
The best way to settle disputes under a supply agreement with a Chinese CM differs depending on the nature of the dispute. If the CM does not meet the product specifications or falls behind on delivery dates, you may want to resolve the issue with the CM first. If that fails to resolve the issue, pursuing monetary damages as well as arbitration in a location outside of China with local laws may be the best option. Since China has signed on to the Convention of New York on Foreign Arbitral Awards, foreign arbitral decisions in more than 160 countries are recognized and enforced in China. In contrast, China may not have any obligation to accept and apply court rulings from your country.
On the other hand, when you find yourself in a situation in which monetary compensation will not resolve the issue, you may prefer to settle the dispute through legal proceedings before Chinese courts. For instance, if CM makes and sells your products without you knowing, either through direct sales to customers or to competitors violating the terms of the agreement or in the event that your CM refuses to exchange your molds or tooling then you’ll need an injunction that stops the CM from breaking the supply agreement.
In these circumstances, having the international arbitration provision can cause harm to your business. It is therefore important to determine the most probable and costly dispute that could arise under the supply agreement and determine the best dispute resolution option the best option for you.
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