OEM

China OEM manufacturer

China’s efforts to improve design capability and develop an international brand are gaining traction. During the last two years, switching from a contract manufacturing business model to prioritising ODM and OBM has grown increasingly common. Suppliers have discovered that focusing solely on OEM might harm their bottom line and overall growth. Not only are such businesses at a disadvantage in pricing negotiations, but many of their products are subject to anti-dumping and anti-subsidy tariffs imposed by importing countries.

Large firms have taken the initial step toward reducing OEM’s part of their company, as has been the case with most changes in China’s export manufacturing industry. However, they cannot entirely stop receiving contract manufacturing orders, which is devastating.

For one thing, Chinese companies are unlikely to win widespread acceptability in traditional markets quickly. Instead, suppliers are easing OEM deals in growing markets in South America, Southeast Asia, and Africa. So  China OEM manufacturers believe it will be simpler to promote OBM lines in those markets since customers are more price-conscious than consumers in other countries.

China OEM Manufacturing Agreements 

Nowadays, China is a big and leading country for manufacturing goods. However, “Made in China” has become a high-profile issue for customers and retailers because of recent product safety crises and continual media attention. This post examines international companies’ contract terms when forming OEM ties with Chinese suppliers. While we outline some of the primary topics we believe the agreement should cover, we acknowledge that each scenario is different and that there is no such thing as a “typical” OEM agreement.

Standard  for Agreements

An OEM may have a standard form agreement that they will gladly supply to international enterprises interested in using their services. While this may initially save expenses and allow the foreign company to ‘gain favour’ with their Chinese counterpart, employing such an arrangement is rarely advisable. Foreign companies should seek legal advice to help them correctly negotiate and prepare agreements. It’s worth noting that we frequently recommend that a written agreement be preceded by preparation and negotiation based on a business term sheet, which lays out the major terms of collaboration. The written agreement is then based on the agreed-upon items in the term sheet.

Important Contractual Provisions

We’ve highlighted a few key (but not exhaustive) terms that should be included in an OEM contract:

1. Products and Specifications: The agreement should clearly outline the products to be created and product specifications, detailed in an appendix (es).

2. Forecasts and Binding Purchase/Supply Commitments: Because OEM Agreements frequently require firm orders to be placed through Purchase Orders, the parties will often designate a minimum commitment on both sides to produce and purchase a certain amount of product within a given period to ensure that there is a binding supply/purchase commitment in the agreement itself. Aside from the bare minimum, the buyer will frequently submit a non-binding prediction to the supplier.Apart from the bare minimum, the buyer will frequently submit a non-binding forecast to the supplier so that the latter can plan and devote necessary resources (often 6-, 12-, 18-, 24- month terms).

3. Price: For the products listed above, the parties should agree on actual prices that will be in place for the duration of the agreement, or at least a portion of it, subject to (we recommend) maximum periodic price increases. It’s also a good idea to add provisions for discounts if certain predetermined purchase volumes are met.

4. Product Quality Control: The buyer and supplier will agree on certain terms to which the buyer will have access. The seller will be obligated to follow to undertake product quality control. Typical terms include access to production locations (sometimes with little or no notice) and ii) random testing of each batch of products before delivery to the customer. Furthermore, depending on the contract’s worth, the parties may agree to have a buyer’s representative on-site full-time or frequently to aid in quality control. (The buyer’s representative may also keep an eye on the supplier’s exploitation of intellectual property and other unethical practices, though their commitment will invariably limit their efficacy to the buyer.)

5. Duration: The parties will agree on a term for their contract, and the buyer may request that the agreement be renewed. This time should be long enough to ensure that the buyer’s initial investment is fully returned.

6. Termination: As with most agreements, termination events will include both those that give rise to immediate termination rights (for example, unauthorised use of buyer’s intellectual property and violation of non-compete terms) and those that require a notice period and the breaching party’s right to remedy the breach (for example, unauthorised use of buyer’s intellectual property and violation of non-compete terms) (failure to supply products meeting specifications).

7. Termination Consequences: In the event of termination, the buyer must state the procedures to preserve the buyer’s rights. Typical terms include selling completed items to buyers, the allowance for partially completed products to be completed and sold to buyers, the destruction or return of confidential information, trademarks, logos, brochures, and other advertising materials.

8. Inspection and Acceptance: The buyer will be given a set amount of time to evaluate the products after they are delivered, but it will be assumed accepted if a claim is not made within that time. Furthermore, it is typical for suppliers to demand that they be released from all further obligations once the buyer accepts the products. Note that we do not propose that buyers accept such terms in their entirety (and give a minimal carve-out and continuous warranty), as the buyer will have limited grounds for a claim after acceptance (even for the use of sub-standard materials, which are often difficult to detect visually).

9. Raw Materials/Components: As part of the quality control process, the buyer should demand that the supplier submit a list of its suppliers, as well as purchase orders for a predetermined period, to ensure that the agreed-upon raw materials/components are used.

10. Insurance: Due to the relatively inexperienced nature of China’s manufacturers and insurance system, firms are frequently underinsured against risks. As a result, it’s a good idea for the buyer to insist on the provider’s minimum amount of insurance.

11. Intellectual Property: All intellectual property used in the manufacturing of the product, such as trademarks, patents, copyrights, and other trade secrets, should be leased to the supplier for the restricted purpose of fulfilling the agreement’s requirements. In addition, the buyer should carefully design associated clauses to prevent the supplier from exercising any ownership rights over the licensed IP.

12. Non-compete: Because an OEM agreement entails a significant transfer of intellectual property and sensitive information, the buyer must ensure that not only the supplier but also its related firms, directors, and management, do not develop new products. (It’s worth noting that failing to accommodate such terms sufficiently could result in the goods being sold not only in China but also in the same markets as the customer, at substantially lower prices.)

13. Arbitration: Due to the concentration of manufacturing in China’s less-developed regions and the cost/time/reliability benefits frequently associated with the arbitration, we advise clients to use arbitration to resolve disputes. Domestic arbitration enables buyers access to Chinese courts for injunctive relief, whereas international arbitration (in any New York Convention signatory state) does not.

Buyers’ rigorous monitoring and enforcement of the agreed terms is arguably more or at least equally significant as negotiating and executing a robust contract.

Finally, while long-term relationships are frequently desired, and we advise buyers to select and work with a dependable supplier, buyers must have one or more alternatives if the principal OEM is obliged to terminate.

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Christophe Rude

Christophe Rude

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