My firm virtually always uses flat fee billing for China OEM supply agreements. We have done so many of these that we pretty much know the range of time one of these will take, even allowing for the required customization and the normal back and forth negotiating that will go on between our client and the Chinese supplier. Our time estimates are nearly always dead on, except for those clients who want the “perfect” OEM agreement.

Those take us less time.

Let me explain.

I am always saying it is easy to write the “perfect” contract and it is. The perfect contract does everything possible to protect your client. At least in theory.

By way of example, the “perfect” OEM agreement would contain something along the lines of the following:

  1. The Chinese supplier cannot raise its prices during the three year term, but the Western buyer has no minimum purchase requirement.
  2. Deliveries more than 10 days late, for any reason, result in a $100,000 cost reduction penalty.
  3. Buyer does not pay for 30 days after goods have arrived, been inspected, and been approved. No time limits imposed on buyer to do the inspection. Buyer pays nothing for non-conforming goods and need not return them to supplier.
  4. Chinese supplier is penalized for a defect rate of more than 1%. 
  5. Arbitration shall occur in Topeka, Kansas (buyer’s hometown).
  6. Chinese supplier cannot sell similar product to anyone else. Buyer is free to buy from anyone else.

Okay, you get the picture. This is obviously a great/perfect contact for the buyer.  

Except there is only one problem. Nobody serious is ever going to agree to this and, in fact, in our experience, contracts like this are automatic deal killers. That is why we should charge less for them. Over the years, we have been asked maybe half a dozen times to write OEM agreements not all that dissimilar from that set forth above. Each time, we have counselled our clients against this sort of agreement, but a few times we have been instructed to go ahead. Once (or maybe even twice), the client remarked on how they bet Wal-Mart has this sort of contract. Our response was that we had seen a number of Wal-Mart’s contracts and though they do tend to be pretty favorable for Wal-Mart, they also typically contain massive minimum purchase guarantees that make the contracts worthwhile for the Chinese supplier.

Now usually when we write a normal (as opposed to “perfect”) OEM contract, we hear back from our client within a couple weeks, discussing potential changes to the contract suggested by the Chinese supplier. We then work for another few days to a week on modifying the agreement to suit both sides and then we are none.  

With the perfect contract, we get silence and then we eventually contact the client. Each time, the client has told us that they have been unable to find a Chinese supplier willing to do business “our way” and so they will be looking elsewhere for their supplies. We suggest they allow us to modify the OEM Agreement and they go back out there, but they say no, they do not want to do business under terms that will put them at risk.  We say okay and move on.

The funny thing about the companies seeking the perfect contract is that they almost always are of a particular type: old line, mid-sized (not small) businesses that have been in business for a very long time and have carved out a pretty good niche and strong brand name in their market. They are looking at China not so much because they have to, but because they believe it will allow them to cut costs and thereby increase their margins. 

In any event, the lack of subtlety in the initial OEM Agreement and the subsequent lack of negotiations and back and forth between the Western buyer and the Chinese supplier means these are the agreements that fall short of our estimated time range. So I guess the next time someone wants the “perfect” OEM Agreement from us, we will have to charge less than for one that will actually work.

What do you think?

For more on China OEM Agreements, check out the following:

Had a nice conversation with a potential client last week. Company has a great new product it wants made in China. Like many companies starting out in China, this one is in the process of shopping for its China lawyers and my firm was one of four suggested to it by its regular corporate counsel.

Our conversation was interesting because we were the fourth law firm with whom she had spoken. This gave me an opportunity to ask how we differed from the other three firms and, not surprisingly, we really differed, both in how we bill for these things and, more importantly, how we typically handle these contracts.

I told this company that we would almost certainly do their OEM contract in Chinese and I quoted them a flat fee for doing that, along with an English language translation. They told me that the other law firms were saying that the contract would be in English and they would “need to” charge by the hour and it would even be impossible to estimate how long it would take due to the negotiations that would take place between this company and its Chinese manufacturer.
I think one big reason so many US law firms do not write their OEM agreements in Chinese is simply because they do not have any lawyers who can read and write Mandarin fluently. My firm has four lawyers (and various others) who can read and write (and speak) Mandarin fluently and we usually favor putting our clients’ OEM contracts in Chinese for the following reasons.

Because international contracts are so often between parties from different countries, they commonly are written in two or more languages. Nearly all of the contracts we draft for our Western clients doing business in China are in English and Chinese (though about ten percent of the time, we also translate them into German, Spanish, Korean, or French as well). This duality of language can, if not handled properly, pose big problems.

When we do a contract in both English and Chinese, we always call for the contract to specify ONE official language to control if there is a dispute. We do not advise drafting a contract that is silent on the official language, nor do we advise drafting contracts that call for both English and Chinese to apply. Having two official languages pretty much doubles the chances for ambiguity and pretty much doubles the attorney time (and fees) that will be incurred in fighting over the meaning of the two contracts. It is expensive enough litigating on one contract; there is no benefit litigating on two.

So the question for us comes down to whether English or Chinese should be the official language of the contract and the answer to that question requires we first decide where we would most like to see disputes resolved. If we go for arbitration in English (and if the Chinese manufacturer actually agrees to this, which is quite rare), then we almost certainly will want English as the official language. But if we decide the Chinese courts will be the best place to resolve conflicts, then we want Chinese to be the official language.

Now I know most of you think the obvious answer here is to do anything possible to avoid Chinese courts, but you would be wrong. Let me explain.

In determining where best to resolve conflicts on an OEM contract, the analysis has to begin with first trying to determine the most likely and the potentially most damaging disputes and then analyzing where best to handle each sort of dispute. Disputes between foreign companies and Chinese manufacturers most often involve the following:

1. The Chinese company provides poor quality product. To say this is common would be an understatement. The best way to deal with a dispute involving the Chinese company providing poor product is usually to seek to work it out with the Chinese manufacturer. If that proves impossible AND there is enough at stake to warrant suing, arbitration is likely going to be the best course of action. Not to minimize the importance of these cases, but they usually involve only one shipment and they usually involve a finite amount of money.

Litigation outside China against a China based manufacturer usually does not make sense. Because most Chinese companies do not have any meaningful assets outside China and because China does not enforce foreign judgments, getting a judgment outside China against the Chinese company will likely have virtually no value. Therefore, there is no point in having a contract that calls for jurisdiction in a court outside China. For more on the difficulty/impossibility of enforcing foreign judgments in China, check out “Taking Judgments To China (And Korea), Let’s Not Sue Twice.

2. The Chinese company manufactures the foreign company’s product without the foreign company’s permission and in direct violation of the OEM agreement. You have a great product and you have taken it to China for manufacturing there. You are currently selling in just a few countries, but your plans call for you to eventually sell into China and India and maybe even Africa some day. All of a sudden, you learn that your Chinese manufacturer is not making just the 100,000 units you ordered, but, in fact, is making 500,000 units and shipping the extra 400,000 to India, Africa and the rest of Asia, where it is selling them for 1/5 of what you are charging.

If your agreement calls for arbitration in Hong Kong or New York, or even Beijing . . . good luck. What you need, and what you need fast, in these situations, is a court order requiring the Chinese manufacturer to stop making your product and to stop NOW. And guess what, pretty much the only way you are going to get that badly needed court order is from a Chinese court, not that that will be easy. If you did everything right with your contract, it will have liquidated damages provisions that will also allow you to relatively quickly secure a judgment from a Chinese court for damages and will also, in the meantime, give the Chinese court a strong basis for freezing the assets of the Chinese manufacturer before you even secure your judgment. The threat of all of this is oftentimes enough to convince the Chinese manufacturer to cease and desist.

If your contract calls for arbitration and you sue in a Chinese court to get an injunction to stop your manufacturer from breaching your contract by manufacturing and selling your product, you almost certainly will not succeed. The Chinese manufacturer will show the court your arbitration clause and request it decline the case in favor of resolving the dispute in arbitration. Once you are in arbitration, you pretty much will not be able to get an injunction or an asset freeze.

It is possible to write your OEM contract to call for arbitration with a Chinese court “carve out” for injunctive relief or an asset freeze, but many Chinese courts do not to enforce these sorts of provisions.

For these reasons, we usually favor our OEM contracts calling for dispute resolution in the Chinese courts. And if you are going to be in a Chinese court, you do want your contract to be in Chinese. The reason for this is simple. If your contract is in English, the Chinese courts will use their own translator to translate it. Translations can be easily manipulated and it is virtually always better to have your contract translated by your own law firm in advance so you know exactly what it says before you sign it, than to have it translated into Chinese by an unknown translator only after you have sued on it.

3. The Chinese manufacturer refuses to return the foreign company’s molds after the foreign company seeks to terminate its relationship with the Chinese manufacturer. This often happens when the foreign company terminates its relationship with the Chinese supplier. Not surprisingly, the key here is to have a contract in Chinese that makes clear that the mold belongs to you and that there will be hell to pay (in legal terms) if the Chinese manufacturer does not return these to you pronto. But what if the manufacturer does not return your molds? Damages are usually not what is needed. You need the molds immediately because without them you cannot manufacture your products. Again, the best positioned foreign company is the one with a contract in Chinese who can go to a Chinese court for an injunction mandating the manufacturer return the molds. Or at least a large enough asset freeze to convince the Chinese manufacturer to back down.

Lastly, and perhaps most importantly, we have become convinced that most (yes most) problems that arising between foreign companies and their Chinese manufacturers stem from a lack of clarity between them regarding the manufacturing terms. The best way we know to resolve those sort of communication issues upfront is to resolve them before the first widget is made and then to memorialize those agreements in a written form that both parties cannot fail to understand. The best written form for the Chinese manufacturer is obviously going to be a Chinese language document.

We have also learned that we differ from virtually all the other law firms in our pricing structure. We gave this client a flat fee price based on the complexity of what we anticipated doing for it. This price was to draft an OEM agreement in Chinese, with an English language translation for the client.

None of the other law firms were willing to give a similar fee, even when the company went back to them (at my suggestion) and suggested they do so. They all begged out, claiming they had no way of knowing how long it would take and so they would “have to” charge by the hour. This is, of course, complete malarkey. (I wanted to use a much stronger word here, but since I long ago committed to writing a blog that I would not mind my now 11 year old kid reading….). If law firms do not know how long these OEM agreements typically take, who does? Seriously.

My law firm has done enough OEM Agreements that we know, within around 3-4 hours, how long 90 percent of them will take, and we are willing to take the risk on the remaining 10%. The real answer is that law firms are simply resistant to change and resistant to taking on any risk on behalf of their clients. For more on how law firms are so incredibly resistant to changing their billing paradigm, check out this recent study resoundingly confirming this.

What do you think?