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China Manufacturing Agreements. Make Liquidated Damages Your Friend.

Posted in Legal News

One of the hallmarks of a good China OEM Contract is that it provides for very specific penalties if the Chinese manufacturer fails to abide by its crucial terms. These penalties will typically be in the form of a liquidated damages provision, which Wikipedia defines as follows:

Liquidated damages (also referred to as liquidated and ascertained damages) are damages whose amount the parties designate during the formation of a contract for the injured party to collect as compensation upon a specific breach (e.g., late performance).

Chinese courts tend to view contractual liquidated damages provisions very favorably and so long as they are not unreasonable, they will usually be enforced. Most importantly, courts will seize Chinese company assets based on a liquidated damages provision and they will seize these assets before trial. Chinese companies know and fear this.

Liquidated damages provisions make sense in many different types of contracts with Chinese companies and they make particular sense in the context of a product supplier relationship.

We most often put in liquidated damages provisions to “encourage” the Chinese supplier to comply with the following:

1.  Shipping Dates.  If the product our client is having made in China is at all time sensitive, it is our practice to specify the delivery date and a penalty to the Chinese manufacturer for not meeting that date. We sometimes set the penalty at a flat dollar amount and at other times, we make it a percentage of the value of the order. We sometimes set out just one penalty and at other times, we hae the penalty escalate as the lateness increases. The key is to make sure the provision is very clear on the date (or dates) that trigger the penalty.

2. Quailty Specifications. We also often put in a liquidated damages provision if the quality of the product falls short on what was promised by the contract. These provisions make particularly good sense if what you receive can still be sold, but for less money. For example, if you are buying a food product that is industry-rated from A to D and you pay for an A product and half of what you get is B, you will be much better off with a contract that clearly states you get $1 for each level below A the product falls than having to prove up your damages by showing how you could have made X dollars more with the A product than with the B you were provided.

We generally strive to make the penalties reasonable not only because the courts are more likely to enforce such penalties, but because the Chinese manufacturer is more likely to take them seriously as well. The thing to remember about penalities is that the best ones need never be enforced because they were so effective in molding the manufacturer to comply.

For more on what should go into an OEM Agreement, check out the following:

  • http://www.vannuyscriminalattorneys.com Joe

    So, basically leave nothing to the imagination, or open to interpretation.

  • http://www.thekoreanlawblog.com Sean Hayes

    Again, same for Korea.
    We have a great deal of issues with other law firms providing us with form agreements and saying that: “this is the normal agreement in Korea.” We always build liquidated damages clauses into our agreements and strongly advise clients not to sign agreements if the counterparty disagrees with the clause. We advise that this is an obvious red flag.
    I had an attorney from one of the self-proclaimed big boys call me a colorful expletive when his client signed the agreement against his advise. He was of course given a talk to by a founding partner at the firm that I am very friendly with. The expletive rhymed with runt -I expect he spent some time in the U.K, since heard the Brits use this term for men and woman. He treated me to a nice dinner, after the talk from his boss, which I failed to attend.
    Love to hear some of your interesting stories with Chinese attorneys.
    Sean Hayes