Negotiating contracts in China

It’s only recently that corporate and commercial laws have begun developing rapidly in China. Sourcing from China isn’t straightforward: agreeing on price and terms will require considerable back and forth. Given these two factors, you’re advised to create a draft contract – an agreement that isn’t finalized – adapted to Chinese laws.

Anyone who has imported extensively from China will tell you that the main goal of the manufacturing contract is to avoid friction and promote buyer-seller harmony. Chinese business culture is based on strong interpersonal relations and a contract is simply a tool to regulate relationships between parties. It involves setting expectations with utmost clarity, stipulating obligation and sanctions, and not taking legal action or arbitration off the table.

Simple language, a version in English and simplified Mandarin Chinese: Chinese suppliers will indicate that they understand you even if they don’t. This mindset is ingrained in their culture as appeasement, and also avoidance - to not ‘lose face’. The draft contract should, therefore, state requirements and terms plainly, and set realistic expectations for both parties.

Explicitly express obligations and deterrents: If you have a contract, you’re already doing better than sellers who haven’t drawn up contracts. Clearly specify the manufacturer’s obligations and the sanctions against them in response to a breach of contract. For example, if dimensions of finished products don’t fall within the acceptable range, the supplier will be obligated to send you a new batch at no cost or apply discounts on all remaining orders.

Enforce the contract with the possibility of legal action: Chinese businesses are used to authoritarianism, and both respect and fear the law. This may not necessarily translate into their dealing with foreign companies. To ensure that your manufacturer honors the contract, it may be necessary to include a threat of legal action or arbitration in retaliation for non-compliance.

Given the expensive and time-consuming nature of a lawsuit, it should always be the last resort. Don’t overlook that there’s also a lot at stake as far as your business is concerned.  As much as possible, you should try to resolve product quality and delivery issues with your supplier. If the supplier has acted egregiously, you can pursue arbitration as a dispute resolution mechanism in China or internationally.

Most foreign companies choose arbitration outside China as it may be more reliable than one within China. Arbitral awards reached in most countries are enforceable in China under the New York Convention.

The most important clauses to Include in your contract

Clauses define the rights and obligations each party has under the contract. Key clauses that should be a part of your contract include:

1. Intellectual property rights

It must be made clear that any patents, trademarks and designs are your property, and that the manufacturer cannot register these rights in China or other countries. Registering your patent, trademark or design in your home country does not provide protection in China. Seek legal advice about registering your IP in China. A local, international or Chinese law firm with expertise in Chinese law and performing similar legal law should be able to guide you correctly.

2.  Confidentiality

A clause around the supplier’s responsibility to maintain the confidentiality of your commercial and technical information avoids legal and ethical hassles. Barring manufacturers from disclosing sensitive information is even more important for OEM and other complex contracts.

3. Quality control

Include a clause specifying all the breaches and incidents that may affect product quality, as well as terms afforded to you (and required of the seller) to conduct quality control. This may include access to the production site on short-notice or without notice; random testing of a product from each batch prior to shipping; and in-process inspections, including allowing the buyer’s representative (such as a China sourcing agent) to be on site to assist with quality control.

4. Subcontracting

Your manufacturer may receive proposals from several foreign companies for manufacturing and distributing goods in China. They may subcontract some of these activities to another factory over which they do not have any oversight. A clause forbidding the manufacturer from subcontracting their obligations to third-parties is necessary.

5. Specifications, price and deliveries

Needless to say, your contract should set out unambiguously details regarding your product specifications (dimensions, materials, finish, colors, labelling etc.). Settle on prices that will be effective throughout the term of the contract or during some duration of the contract, with a maximum limit on periodic price increases.

The port where your products will be delivered, and payment period (ex: 30% prepayment, net 30 terms, the date on which payment will begin, and so on) are other pragmatic clauses that your contract should not miss out.

Navigate less, get your products out faster

Sourcing from China is complex and missteps can cost you dearly. If you have time to scour the country’s manufacturing landscape and the willingness to educate yourself on Chinese business culture and relationship-building, you can make savvy decisions and outshine the competition. On the other hand, if you wish to focus your energy on running other aspects of your business and want to entrust sourcing to a third-party, a sourcing agent can be a valuable partner.