Be like water making its way through cracks. Do not be assertive, but adjust to the object, and you shall find a way around or through it. If nothing within you stays rigid, outward things will disclose themselves.
Empty your mind, be formless. Shapeless, like water. If you put water into a cup, it becomes the cup. You put water into a bottle and it becomes the bottle. You put it in a teapot, it becomes the teapot. Now, water can flow or it can crash. Be water, my friend.” – Bruce Lee
You might be thinking, “Did he really just open this article on contracts in China with a Bruce Lee quote?”
I did…But this in my opinion encapsulates doing business in China and how you should view agreements perfectly. I’ve learnt this by being based in China fulltime since 2014, managing mass productions orders worth 6 figures in my consulting company Source Find Asia, interviewing various China experts on the Made in China Podcast, and being surrounded by a community of over 200 China entrepreneurs, called Enter China – which I’m now partner of.
I decided to write this because of a serious debate we had within the community on whether contracts matter in China. I have my own experience with this but, I also took the time to interview four “China vets,” with a collective of close to 40 years of experience doing business in China.
Throughout this article I’m going to reference their thoughts and show you what the most common documents are when dealing with Chinese manufacturers, what information you should have listed in your agreements, and what the value of having them in place is.
So Do Contracts Matter in China?
A few days ago I posed that same question to Nick Ramil, part of the founding team at IoT accelerator Brinc.io, “At the end of the day if Apple can’t defend the iPhone, if Michael Jordan couldn’t defend his name – quite honestly, they’re more or less the equivalent of toilet paper.”
Believe it or not that’s a yes…contracts do matter, just definitely not in the way a typical contractual agreement would in most countries outside of China.
What Contracts to Focus On and What Are They?
The non-disclosure agreement (also commonly known as a confidentiality agreement), is a pretty straight forward contract that lists two parties wishing to share private information – that should not be disclosed to outside parties.
When to Use & What is The Purpose?
If you’re working with an ODM (Original Design Manufacturer) meaning you’re designing a product to be manufactured from scratch.
You may also be working with an OEM (Original Equipment Manufacturer) which means you’re private labeling products that have already been made. However you might have customized packaging or make certain tweaks to the current product which would make it unique.
Getting an NDA in place is to discourage factories from sharing your design files, showing your production to other customers when they visit the factory and listing your products on Alibaba or anywhere else.
Note* You should get your suppliers to sign the NDA PRIOR to sending them any sort of design files.
Kenny Miller, 10 year China entrepreneur, now factory owner and Enter China member – had this to say, “Even though I rarely have factories sign NDAs these days, you can have a factory sign an NDA if you’re really worried about them stealing your products and they’ll be happy to do it.
But make sure it’s in English & Chinese, get a Chinese lawyer who knows what they’re doing to tailor the agreement because every product is different and will have different tolerances when it comes to breaching the agreement.
If it’s just in English the factory can easily say they didn’t understand what the contract said if it does go to court.”
In my experience most factories understand the need to sign an NDA when they know you’re about to send them a CAD file or Techpack for example. It doesn’t hurt to have them sign it and allows me to gauge how professional they are early.
Now, will this 100% prevent a factory from listing your product on Alibaba?
The reality is unless you’re a huge brand with a team of Chinese lawyers, it’s not worth the time or resources to spend trying to legally stop a factory from breaking the terms of your NDA.
The good part is that most factories just want to manufacture products and are not concerned about copying a non brand product with no guarantee of sales.
On top of that they actually respect the terms of an NDA and if they do list your product online – they’ll likely take down the listing if you tell them to.
The Sales Agreement
The sales agreement is probably the most crucial and misunderstood document for foreign buyers in China. This is the document that lists the terms and conditions of the transaction between you the buyer and the supplier.
It should include details such as:
- Product Descriptions
- Pantone Colors
- Mold (if needed)
- Samples Run (if needed)
- Per Unit Costs
- Payment Terms i.e. EXW, FOB
- 30% Deposit Upfront
- 70% Upon successful Final QC Prior shipment
- Bank Account of Recipient
- Order Quantity
- Lead Times
- Mold Production (if needed)
- Sample Run (if needed)
- Mass Production
- Quality Expectations
- When and what type of QC Inspections (i.e. FRI – Final Random Inspection)
- Based on AQL Level I, II or III?
- Action Items in case of Failed QC Inspection
- Are they remaking the product?
- Providing a credit on the next order?
- Replacing the defective products?
While you want to make this document as detailed as possible remember to be fluid during your production.
And again don’t forgot to create the agreement in English & Chinese, if that’s not practical at the very least have the finer points translated into Chinese.
When to Use & What is The Purpose?
You should have some sort of sales agreement in place before sending a deposit on every order.
I ALWAYS get my suppliers to sign an agreement whether the order is worth $1,000 or $150,000. You want to put your best foot forward and show suppliers that you’re serious – especially as a small business or early stage entrepreneur.
The real value is that it helps with organization, it’s used as a guideline and emphasis on quality control. It should allow the factory and the clients to have the same expectations on how the production will flow and how the product will turn out,” said Michael Schierhorn, (a.k.a ChinaMike in the community) my business partner with 8 years of sourcing experience on the ground in China.
I’ve personally had a factory tell me that our mass production would be a 40 day lead time including weekends.
Sounds like they’re hustling seven days a week right? Nope, they meant Monday to Saturday not Monday to Sunday.
The purpose is to make sure that the buyer’s expectations are on the same level as the supplier.
Note* It’s your responsibility as the buyer to provide the sales agreement and define terms to the supplier. Only you know 100% how you want your product to turn out.
This is something that the entire factory staff and the buyer can use as a “reference” (keyword being reference) in case there are any small disagreements, delays, quality issues etc. It’s not going to be an iron clad agreement that is followed to the tee but, it does help.
Getting a factory to agree to terms AND follow them, starts with finding the right factory.
Pro Tip* Get That Red Chop!
Hand written signatures by Chinese companies aren’t legally binding, what makes a document official in China is the red company stamp (or chop). If you’re signing an agreement with a supplier make sure the factory puts their red stamp on it.
Kenny shared this gold nugget on the topic,
The importance beyond making the document official, is that quite often you may be dealing with a sales rep and they may agree to all your points verbally but, when some issue come up during production they may claim they didn’t agree to those points.
Now you’re in a he said, she said situation without a stamped agreement…
But if you go to their boss with a stamped agreement, the boss is more likely to side with you and honor what was written down in the agreement. They may also want to change that point on the next order but at least you’re getting what you agreed to on this one.
What you have to remember is most Chinese factories are not out to cheat you but, mistakes do happen.”
Want a free copy of our sales agreement?
Click here to download now!
P.I. – Proforma Invoice
The proforma invoice is the most simple and common document you’ll deal with in China manufacturing. It’s always provided by the supplier. Think of the P.I. as it’s more affectionately known as here, as a “sales agreement light.”
It usually lists:
- The Date 😉
- Basic Product Descriptions
- Order Quantity
- Lead Times
- Banking Information
Factories will send a P.I. once you’ve finalized all the details of your order. From the manufacturer’s perspective it’s an official quote, they’re ready to get paid and commence mass production.
Don’t sign off on a mass production with a P.I. use it as the framework for your sales agreement as the P.I. rarely has anything listed about quality control expectations or late production penalties.
Less Commonly Used Contracts
- Exclusivity Agreement – An agreement between the buyer and supplier that restricts the supplier from selling to another buyer. It could make the supplier exclusive to the buyer in one market or it could be global.
Exclusivity agreements can be negotiated but, you need to be pushing some serious volume consistently for this to be attractive to a supplier.
- NNN Non-disclosure, Non-circumvention and Non-competition Agreement – A super sexy and seriously (I like alliteration) extensive agreement which encompasses:
- An NDA (See description above)
- A Non-circumvention – meaning the parties in the agreement can’t indirectly or directly go around each other to get involved with 3rd parties or entities introduced by either side.
- A Non-competition – meaning the supplier can’t go into direct competition with the buyer.
As you might have guessed already, unless you’re going to be placing a multi-million dollar order (with an ODM) – you probably don’t need to be signing an NNN right now. Focus on making the best product possible and building up your business.
Founder of Insight Quality Andy Church said it best when I spoke to him,
Don’t spend money on a lawyer to draft up these contracts in China, especially if you don’t even understand what they mean and if they’re enforceable.”
But Are They Enforceable?
Legally yes of course but mostly no not really… Let me explain.
As a foreign entity in China it’s going to be extremely difficult to fight a Chinese supplier.
Who do you even go to if the contract is breached?
What type of court do you go to?
How much is it going to cost?
What’s the timeline?
Even if you have the resources, the reality is the court is more likely to side with the local business.
All you have to do is look at the current trademark lawsuit with the iPhone brand in China or look back to 2012 when Apple had to pay $60million to a Chinese company to get the rights to the iPad name in China – 2 years after the original launch of the iPad…
Insert Nick Ramil,
China plays by it’s own rules and at the end of the day China cares about China. They’re focused on making themselves self sustainable, that’s why they localize everything and shut out foreign competition when it comes to apps and software development. Just look at how DiDi bought out Uber.”
Why Even Bother Then?
Because there’s light at the end of tunnel.
I’ll give you an example.
Recently we sourced and managed production for one of our Amazon FBA clients. We went through our usual process of sifting through & vetting about 30 – 50 suppliers before narrowing down the best 3 – 5. Visited the factories, chose our supplier because of their experience and how professional they were. Then we started going through the sales agreement terms with them.
What usually takes a few hours, maybe half a day – took three days!
Not because they had a lot of issues with our terms, they just had to run through & sign off every detail of the contract with upper management – not your typical mainland factory to say the least.
This was a good sign.
Long story short, they passed the final QC and the quality of our product was really really good.
The only issue was the mass production was one full work week late. The delay itself wasn’t a surprise, it was communicated to us one month earlier.
As per our sales agreement we deducted a pre agreed percentage (of the total order) from the final 70% deposit. Which basically saved us $1,500.
Of course 9/10 factories in China probably would have refused to take the hit and we probably wouldn’t have done anything about it. But at the end the day taking the time to find, build a relationship with a professional supplier and draft up a contract is what allowed us to be compensated for the factories’ mistake.
Focus on finding the right suppliers and building those relationships.
China Vets Power Round
“I’m still owed around thousands of dollars and products, but I’ll never see them. This was part of learning how to do business in China as places like EC didn’t exist before.
It leaves you open if you don’t have one in place, and it sets baselines in writing but, if you think you can go to lawyers as you would in the USA, you’re mistaken.”
“5 years ago I would have laughed at the idea of a contract. However, since we restarted the company in 2015, we’ve been more systemized and see more value in creating contracts now.
It is an acknowledgement of responsibility from the factory, it helps set expectations and guidelines.
Larger companies dealing with large manufacturers might put more emphasis on it. But the handshake agreement is still more common, it’s about trusting your supplier and building up your Guanxi.
To me, having checks and safeguards during the production to make sure you’re getting what you want it is the most important point.”
“Contracts aren’t worthless but they aren’t a save all. It’s important to understand that if the parties doesn’t honor the contract it’s extremely difficult to enforce.
They do bring validity to the buyer but you can also communicate validity in different ways like:
- The volume of the orders.
- Frequency of orders.
Using a contract to validate the buyer is good initially but, it’s not a longterm solution. As for details of the contracts make sure you understand them. You have to ask what is non-circumvent, what is non-disclosure, why is it important to the factory and to the buyer? These need to be understood by both parties.
The real value is using the contract as an excuse to go through the points of the production”
“I do think the contract is important, mostly to make sure there aren’t any misunderstandings. It needs to be in English & Chinese, you need to write down all your requirements, specs, what the payment terms are, QC expectations etc.
This is just so if the factory comes back and says they don’t want to do something or want to change something you can point to the document and say no because we already agreed to xyz and you gave your stamp on it.
But don’t get comfortable just because you’ve signed an agreement with them.
You need to still be on top everything.
What goes a really long way is building a relationship with the factory and visiting the factory in person prior to starting the order is huge in showing them that you’re serious about building a relationship with them.
I look at the relationship as more of a contract.
Show them that you’re there for them as much as they’re there for you.
Work with the factories in a respectful way, be open and honest.
Above all always do what you say, once you gain their trust and loyalty they will do anything you want them to do and the contract won’t be so important.”
As Michelini said in a previous article “manufacturing is a bitch…”
But I honestly think factories in China are slowly changing (especially in Southern Coastal China).
As they work more with foreign clients and study their needs, as the old school factory bosses retire and their well (often western) educated offspring take over, as the government implements more rules & regulations around minimum wages and working conditions etc.
There seems to be a slow shift towards legitimizing operations.
Contracts matter in China but don’t think just getting a detailed contract in place, means that’s the end of your job.
To ensure your agreement is honored you have to be vigilant, you have to work within the factories’ system in order get what you want and you have to empty your mind, be formless. Shapeless, like water.
Be water, my friend…