Who should sign your China OEM Agreement?
Who should sign your China OEM Agreement?

Got the below great comment/question today:

I would love to see you write about Taiwan / HK being “not” China, but from a different perspective. What advice do you give to a foreign company that plans to engage TW-based (or truly HK-based, e.g. been based in HK for 30-40 years) manufacturer, and said TW/HK company owns (though often, especially in the case of TW companies, via some Cayman/BVI/offshore entity) its own factory in China where the goods will actually be produced.

For many good business and tax reasons, the TW/HK company wants their HQ office to be the supplier of record to the foreign (e.g. US/UK) customer, and for the customer to pay the HQ office for the goods (usually so the factory can keep most profits outside of China and not have the problem of extracting money from China, which you write about so well).

So the US/UK customer will buy goods from (and pay money to) a TW/HK HQ operation, which in turn will sub-contract the manufacturing to their China-mainland subsidiary. In these cases, does your firm typically advise the client to have a contract with the TW/HK HQ, or solely with the China factory (even though they are not paying the China factory directly), or separate contracts with both entities?

You’ve written so much wonderful work on working with “Chinese suppliers” but in so many cases these suppliers are the product of FDI from TW or HK (or Korean, Japanese, US, German, etc) companies. Are the rules of Development Agreements and OEM contracts fundamentally different when a) the china factory has a foreign owner) and b) the customer will pay the foreign owner (rather than factory directly) for the goods?

It is a great question because the situation of a non-Chinese company operating a Chinese factory has become so common and it invariably presents legal problems for the buyer. The issue typically presents itself when the Hong Kong or Taiwan entity wants the OEM agreement (aka the contract manufacturing agreement or  supplier agreement) to be with it and not with the PRC entity that will actually be manufacturing the product. Our China lawyers deal with this issue more than half the time when drafting China OEM agreements, usually in one of the following three situations:

  1. The Hong Kong/Taiwan entity is the parent company of a PRC WFOE, and that WFOE owns and operates the factory that manufactures the product.
  2. The Hong Kong/Taiwan entity has no ownership stake in the PRC entity that owns the factory. Rather, some or all of the owners of Hong Kong/Taiwan entity are also the owners of the PRC entity. Or maybe the owners of the Hong Kong/Taiwan entity and the PRC entity are part of the same extended family.
  3. Neither the Hong Kong/Taiwan entity nor its owners have any financial interest in the PRC entity. The Hong Kong/Taiwan entity is merely a sales agent for the Chinese factory.

Though it is nice to know the real relationship between the Hong Kong or Taiwan entity and the PRC factory, it usually isn’t critical for determining how to write the OEM contract. We generally prefer our clients’ OEM agreements to be with the PRC entity and not with the Hong Kong/Taiwan entity for the following reasons:

  • We know the PRC entity has assets because we know it owns a factory. Oftentimes the Hong Kong or the Taiwan company has no assets beyond a rented office with a few chairs, desks and computers. We would much prefer our client have contract and litigation leverage over a company with a factory than a company with some chairs. Also, a company with a factory is more likely to abide by a contract than a company with some chairs.
  • Our OEM agreements contain non-disclosure, non-compete and non-circumvention provisions. See China NNN Agreements. The PRC entity, not the Hong Kong/Taiwan entity, is by far the most likely entity to manufacture and sell our clients’ products in competition with our client. We therefore very much want that manufacturer to have signed a contract that prevents them from doing such a thing.
  • If the manufactured product is of poor quality or delivered late, it is easier to deal with the entity that actually did the manufacturing.
  • We want the payments to go to the entity that actually does the manufacturing, rather than an interposed Hong Kong or Taiwan entity that receives payment for the manufacturing, and we want the OEM agreement to reflect this. For one thing, the PRC factory could claim it was never paid by the Hong Kong or the Taiwan factory, and use that as a reason not to manufacture for our client. Yes, this problem can be dealt with by contract, but doing so complicates things, not least because it brings another jurisdiction into play.

For more on why it almost always makes sense to contract with your PRC manufacturer, check out China Product Outsourcing. How To Distinguish Between An Agent And A Manufacturer and China Contracts, But With Whom?