We are constantly — both on this blog and in the real world — extolling the virtues of foreign companies having appropriate contracts with their Chinese manufacturers. Yesterday provided me with two instances highlighting that need.
The first was an email from a company asking whether my firm’s China lawyers could assist them in seeking a refund of around $160,000 for bad product received from their Chinese manufacturer. The email on that is as follows, doctored a bit to hide any identifiers:
Our company designs and fabricates widgets out of Chicago.
At the end of 2014, we purchased a large qty of widgets (about x number for $160,000) from a company in Shenzhen.
We received a spec sheet for the widgets which I attach here. These specs match our standards and the CA compliance laws.
We cannot use the widgets that we received as they will not last and we are losing a lot of money and the delay in time is costing us clients.
Can you please advise if you can help us? We would like to be repaid by the company that manufactured and sold us this product and also receive compensation for the money the additional production time has cost our company.
I look forward to hearing from you.
We responded as follows:
Thanks for contacting us.
Do you have a written contract with the Shenzhen company? Is your OEM contract in Chinese? Does it have the Chinese company’s seal on it? Does it provide for specific damages for failing to satisfy quality requirements? Does it provide for litigation in China and not the United States?
If you answered yes to all of the above, we can help you and we would be interested in doing so. If you answered no to any of the above, we would not be interested in pursuing this and I would strongly suggest that you do things differently the next time you order product from China. For more information on what these contracts should look like, please go here, here, here, and here.
As is virtually always the case, the email we got back led us to decline the representation.
Only hours later, I was called by Everett Rosenfeld at CSNBC regarding Lumber Liquidators recent product problems. The article related to that interview is ‘Made in China’ doesn’t have to mean ‘dangerous.’ The article quotes me as follows:
“Probably 98 percent of the time when there is a product problem in China, a lot of the blame lies with the American company,” said Dan Harris an attorney who edits the China Law Blog.
Harris said he receives about five requests each week from Western companies asking for legal help on problems with Chinese suppliers. But his firm always turns down those requests because “they are usually not in a very good position to get compensated.”
The only way for companies to protect themselves, he said, is to ensure that they have written the right kinds of contracts beforehand. “If they have a really good contract with their supplier, then they should be in pretty good shape,” he said. “If not, then they could have a problem.”
The key to contracts, he said, is that they should “scare the heck out of a Chinese company” with very specific details about quality expectations, as well as minutia concerning subcontracts and repayment for bad products.
This is not quite right. I said that protection from China product problems rests on three legs: One, choosing the right partner. Two, having a China-specific contract. And, three, quality control monitoring. All three are important. Once you have a problem, the contract is the only thing that can save you, but to prevent the problem, all three are crucial.
Late last year we did a post entitled, Five Keys To Getting Good Quality Products From China, in which we briefly listed out the five keys to securing good product from China. That post follows:
Our China lawyers have assisted hundreds of Western companies with the legal side of having product manufactured in China. That experience has enabled us to see what works and what doesn’t for China manufacturing. If you want to greatly increase your odds of getting good quality manufactured product from China, you should do the following five things.
Use a Good Company. Sounds rather basic, but we constantly see this rule violated. If you do nothing else that we suggest in this post, do this one thing as it matters as much as all the other things put together. For how to learn more about “your” China company, check out Basic China Due Diligence. Is This Chinese Company Legitimate?
Use a Good OEM Agreement. Good contracts ensure that your Chinese company knows what is required of it and what will happen if it fails to provide it.
Use Detailed Documents. Chinese factories tend to do exactly what you tell them to do. This means that what you tell them to do needs to be clearly conveyed and that means your instructions and specifications should be detailed and in Chinese. Be specific.
Visit the Factory. Either your own people or a third party QC company should pay regular visits to your factory. Doing this allows you to make sure it understands what you wand and lets them know that you are serious about making sure you get it
Inspect. Perform regular product inspections appropriate to the product you are having made. Do the above and your odds of getting good product go way up. Don’t do the above and they go way down.
In other words, good contracts are important, but so are other things. For more on this check out How To Prevent ‘Made In China’ Product Labels From Leading To Lawsuits Made In The U.S.A.
The CNBC article also quotes international arbitration attorney B. Ted Howes who says that “[G]enerally speaking, litigation in Chinese or U.S. courts is ineffective, Howes said. Chinese firms enjoy an advantage in their home-country courts. And any judgment in the United States is “essentially a worthless piece of paper” unless the manufacturer has American assets or has holdings in a third country that shares the right treaties with the United States. We agree that U.S. judgments are usually not worth the paper on which they are printed. In Enforcing China Court Judgments Overseas. Yeah It’s Possible, we made clear that U.S. court judgments are usually of no value against Chinese companies:
When it comes to enforcing US court judgments in China, the law has been clear and remains clear. China won’t do it. Not now. Not later. Maybe not ever.
Howes goes on to advise that “the most successful way for American firms to seek an award from a Chinese supplier is to enter into international arbitration—a process that requires the right provisions in a contract before any dispute arises.” On this we vehemently disagree. Chinese litigation is not great when pursuing Chinese companies, but neither is international arbitration. But putting a Chinese litigation provision in your manufacturing agreement is most of the time the absolute best way to avoid product problems.
To understand why this is the case, one must understand Chinese law and, most importantly, one must understand the role that contract damages plays in pursuing Chinese companies in litigation. In China Commercial Contracts: Writing the Contract Damage Provision,we explain contract damages and why they are so effective:
In our standard commercial contracts we often include a specific damage amount for certain (not all) violations of the contract terms. We work with our clients to ensure that such provisions are not a penalty, but rather an honest assessment of what real damages might result from the breach. This system has worked well in China and actually helps prevent litigation due to the certainty of result these contract damage provisions provide.
Common law lawyers often express concern about such contract damage provisions based on the general common law aversion to “liquidated damages.” This concern shows a lack of understanding of how the Chinese civil law system works in the realm of contact damages. The Chinese side will also often object. Their reason is clear: they understand the effectiveness of such provisions and they want to escape from this very real threat.
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We also provide for contract damages because though China has no law/equity distinction (unlike common law countries), injunctive relief generally does not work well in China. We therefore want to have an agreed contract damage amount in cases where the actual amount of damages is difficult/impossible to calculate. In these cases where there is no clear monetary damage (the classic common law injunctive relief situation), the PRC courts generally have NOT allowed defendants to argue that no relief should be awarded. For this reason, though there is risk that the PRC court will reduce the contract damage amount, the risk is for a lower award. The risk is not that there will be no damage award at all or that the contract will be invalidated. Chinese courts very much prefer making a monetary award as an alternative to issuing an order (injunction) that they know they cannot enforce.
Mr. Howes falls into the common trap of Western lawyers: believing that the only reason for a good contract is to be able to sue on it and win. There are actually three main reasons for having a good contract and in countries with less developed legal systems, the other two rise in prominence. Those other two are to achieve clarity between the parties and to increase the odds of never having to sue.
In China Joint Ventures Are Back And Contracts Are The New In Thing. The New Reality Of China Foreign Investment and The New Role Of Written Contracts For Product Purchases In China, we wrote about how contracts with Chinese companies were increasing in importance and in value and we set out the following three key provisions for making your China contract effectively enforceable in China:
1. Enforcement is in China through litigation in the Chinese court system.
2. Governing law is Chinese law.
3. Governing language is Chinese language.
For more on what it takes to have a China contract that works, check out Using English-Language Contracts in China: My Q&A with China Law Blog.
Bottom Line: There are many things that American companies can and should do to help ensure good product from their Chinese manufacturers. The companies that engage in those “many things” greatly reduce their odds of having product problems.
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