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:

Manufacturing agreements between foreign companies and their Chinese manufacturers typically come with all sorts of clauses dealing with choice of law, indemnification, time of delivery, failure rate, price, payment, and various other contractual provisions. But, it is oftentimes the Bill of Materials that will make or break the success of the manufacturing relationship, but far too often this document is either ignored or given far too short a shrift.

The Bill of Materials is simply a list of the components to be used in fabricating the proposed product. A good Bill of Materials, inserted as an appendix or addendum to an Original Equipment Manufacturing (OEM) agreement, should specify in excruciating detail exactly what the Chinese manufacturer must use in manufacturing the product. A well drafted and precise Bill of Materials minimizes the likelihood of confusion and future mistakes, which in turn saves money. It can help minimize product defects and recalls.

I have seen far too many OEM manufacturing agreements that did not have a Bill of Materials and far too many OEM agreements where the Bill of Materials was not made a part of the contract. Perhaps even worse, I have seen Bills of Materials that were made a part of the contract, but that allowed the Chinese manufacturer to substitute any component in the Bill of Materials whenever it felt like it. There is oftentimes nothing wrong with allowing your Chinese manufacturer to make substitute materials with your knowledge and approval, but there is a lot wrong with a Bill of Materials that gives your Chinese manufacturer complete discretion to substitute in materials.

When a problem arises, you should be able to cross-reference your Bill of Materials with the actual product to see if the correct components are present. When I see Chinese manufactured products with high return or defect rates, the cause is almost invariably the Chinese manufacturer having used cheaper components. But far too often, I also find that there was nothing in the OEM contract or in the Bill of Materials (or in the two of them working together) that contractually prevented the Chinese manufacturer from having done exactly what it did.

If you want to reduce your chances of defective or dangerous product, you cannot just rely on your Chinese manufacturer to do the right thing in terms of your product’s materials or components. It is your responsibility to make sure your Chinese manufacturer is using the correct materials in manufacturing your product. A well drafted Bill of Materials is the first step towards that.

For more on OEM agreements, check out the following: