Manufacturing Contract: Fear And Its Impact On Payment Terms

In this post, I’ll discuss the major risks each party is afraid of and their impact on payment terms in the context of the customer/supplier relationship, as well as where a manufacturing contract fits into the picture.

When outsourcing the manufacturing of your products there are always unknowns, for both parties, and fears that things won’t go well. This could be when working with suppliers in China, Thailand, India, Turkey, or just about anywhere.

The concerns of both parties can influence the relationship negatively. Here’s why that’s not good…

What the customer fears

The customer is most afraid of the following:

• The supplier does a bad job that leads to poor quality products and/or shipment delays. And it sometimes happens because the supplier subcontracts the work to a manufacturer they have little control over.
• The supplier doesn’t respect their product IP rights, sends information to other companies and/or becomes a competitor of the buyer.

Resulting in…

The customer wants to be able to sue the supplier in a country where they have assets and the courts will enforce the contract. For instance, having a Chinese supplier bound by enforceable Chinese laws.

What the supplier fears

The supplier (manufacturer) is mainly afraid of not being paid by the customer.

Resulting in…

As a result, the supplier wants to be able to sue the customer in the customer’s country, as long as that country’s legal system is not too bad.

The two conflicting worries can strain relations

As you can see, there is a conflict in ‘needs’ brought on by the two parties’ differing fears.

• Customers often ensure the manufacturing contract calls for litigation (sometimes arbitration) in the supplier’s country.
• The supplier then tends to be quite conservative with payment terms. They want to make sure all the money has been transferred relatively early. That sometimes means payment of the balance amount before shipment (which is a risk for the customer).

However, hopefully, a manufacturing agreement or contract can/should be agreed on that is suitable for all parties and includes payment terms that are more reasonable.

The typical arrangement, with a manufacturing agreement

When an experienced buyer is involved and the amount of money at stake is high, here is how things typically turn out:

• If the supplier is from mainland China, they usually don’t have a well thought out agreement template. The buyer comes out with their own template, often with help from a lawyer.
• Again, if the supplier is based in mainland China, the particularities of the legal system there make it important to use a template that was drafted specifically for buying products in China, and that calls for litigation in China. (Arbitration is usually not favored, since speed of resolution may be essential — imagine if the supplier is selling the customer’s product to competitors, for example.)
• Both parties go clause by clause and try to find an acceptable “happy middle”.
• There are usually special terms about the case where a high proportion of products is found defective. That’s a key concern for buyers.
• The payment terms are usually 30% before production and 70% just after shipment. It seldom gets more favorable to the buyer’s side.

Learn how to create a valid manufacturing contract in China, with a focus on protecting product IP.

Additional protections to a manufacturing contract

As well as a manufacturing contract, there are other documents that can enhance the protections enjoyed by customers and are not likely to deter suppliers from woking with you if demands/clauses in them are reasonable.

Product development agreement

If the supplier is doing some work where they are designing and developing the product, having them sign a product development agreement will help clarify who owns what IP.

Learn more about product development agreements here: Exploring Product Development Agreements For Importers [Podcast]

Some suppliers who specialize in a certain product type may be well-equipped in personnel, experience, and equipment to help develop your similar new product. But this work doesn’t always come for free…they may do it with the assumption that they then own your product designs, tooling, etc. An agreement helps keep control of IP in your hands.

NNN agreement

An NNN agreement complements a manufacturing contract, clarifying what the supplier may or may not do with product IP. NNN follows a logical path:

• Non-use – the supplier cannot use your IP in any way.
• Non-disclosure – the supplier cannot make public your IP or share with others (such as a friend’s factory, or via unauthorised subcontracting).
• Non-circumvention – the supplier cannot start making your products themselves and selling at a lower price to steal your customer base.

These 2 agreements may be included as a part of your manufacturing contract.

Disclaimer

Here at Sofeast, we are not lawyers. What we wrote above is based only on our understanding of the legal requirements. We do not present this information as a basis for you to make decisions, and we do not accept any liability if you do so. Consider consulting a lawyer before making legal decisions.

Wondering where to start with IP protection in China?

When developing and manufacturing your new product in China protecting your product’s IP is a very valid concern. We’ve all heard about the various copycats there who can grab your IP, copy it, and beat you to market ~ that’s a nightmare for most businesses and entrepreneurs who’ve invested a lot of time, effort, and money into making their new product a reality!

So, to help you take control over your IP, we created this free guide that guides you through how to protect IP, pitfalls to be wary of, and common activities and legal tools you need to utilize in order to reduce the risks of China IP theft.