Dan Harris at CLB did a post that I really liked about term sheets entitled “China OEM Manufacturing Agreements. What Should Go In Your Term Sheet?” Not that I don’t like Dan’s other work, but this is one worth reviewing because you can see a mixture of experience (expertise), business judgment, curiosity, and attention to detail that is useful not just for China legal work, but frankly any legal work.
His tips on questions to ask for such a term sheet were good enough for me to just rip verbatim.
- Identify the entity that you will be paying; it may not be the factory itself but rather a holding company in Hong Kong/Singapore/Taiwan/etc. In general, unless this entity is acting as an import/export agent for the factory, the contract will be with the entity you are paying, and if things go South, your recourse will also be against that entity.
- Think about more than just shipping terms. Think also about packaging terms (for each [widget], for each box, etc.)
- You ABSOLUTELY want an inspection clause. Quality control is extremely important. In an ideal world, you would inspect after delivery and before you pay a dime. But few contracts are ideal. Think about when you want to inspect (probably both before and after delivery).
- What will happen with defective product? The inspection process is closely linked to what you do with defective product. The worst outcome for you would be for the factory to sell your defective [widgets] on the grey market. Do you want to witness the destruction of defective product? Require a certification of destruction? Have the defective [widgets] shipped to you so you can destroy them? Something else? Also, think not just about when to inspect, but of what an inspection will consist. Will you inspect every [widget]? A statistically significant number?
- What will constitute “epidemic failure”? Five percent of a shipment? Three percent?
- Think about warranty provisions, and how they will be implemented. How long will the warranty last? Who will pay for you having to ship back the returns?
- Think about timing — late shipments are obviously bad, but early shipments can be bad too, especially for seasonal items.
- How and when will prices be determined? If the factory wants to change prices, how much notice must they give you? Are there built-in volume discounts?
- What happens if you submit a purchase order and the factory doesn’t accept it? How long do they have to accept or reject a purchase order?
- How much lead time must you give between a purchase order and the delivery date for that order?
- Will you be selling the [widgets] all over the world? Will you be selling them in China?
- Will the factory be using subcontractors? Do you care?
- Do you want to restrict the factory from working with and/or contacting any of your competitors?
I normally dont block quote huge amounts of text, but I just had to do it this time around. Why? Because often lawyers are afraid to ask questions unless they’re a litigator doing a cross examination. It’s usually the very junior lawyers who get an assignment or are told to do a task, and then they do it… and that’s it. I like seeing stuff get done, but where the legal thinking comes in is around all of the questions and open details that can create liabilities. You’ll never get a contract that’s bulletproof, though some confidently claim that they can draft such a thing. (I call B.S. as a litigator, we’ve litigated everything!)
I would commend anyone learning to practice law to learn to ask questions like these. Obviously not the same exact ones, but this thought process goes for any situation. Got an HR matter? Plenty of questions around context and facts. Patents to prosecute? Again, plenty of questions around defensability, purpose of the patent, etc. Works in every legal arena I can think of. This is what professors in law school call “thinking like a lawyer”.