A foreign company buying from a Chinese supplier needs a contract that does more than state the product, quantity, and price. The contract needs to define what happens when the goods don’t meet specifications, when the delivery is late, when the supplier uses unauthorized subcontractors, or when a dispute arises that can’t be resolved informally.
China is the world’s largest manufacturing economy, and the contract law governing supplier relationships is well developed. But the practical reality of enforcing a supply agreement against a Chinese manufacturer is different from enforcing the same contract against a manufacturer in the buyer’s home jurisdiction. The contract needs to account for those differences.
Product Specifications and Quality Standards
The product specification in the supply agreement is the benchmark against which the goods are measured. A specification that’s too vague — “industrial grade stainless steel” — gives the supplier room to deliver a cheaper grade that meets any reasonable interpretation of “industrial grade.” A specification that’s too detailed — specifying every dimension, tolerance, material grade, and testing protocol — protects the buyer but may be impractical for the supplier to comply with consistently.
The sweet spot is a specification that identifies the critical parameters — the ones that affect the product’s functionality, safety, or regulatory compliance — and specifies the testing methods and acceptance criteria for those parameters. Non-critical parameters should be specified with tolerances that reflect the supplier’s manufacturing capability, not the buyer’s ideal.
The quality control clauses should specify the buyer’s inspection rights. The buyer should have the right to inspect the goods during production — not just before shipment — and to reject goods that don’t conform to the specification. The inspection right should include access to the supplier’s factory, testing records, and quality control documentation.
Third-party inspection is standard in China supply agreements. A clause that requires inspection by a named third-party inspection company — SGS, Bureau Veritas, TÜV — before shipment gives the buyer an independent assessment of quality and reduces the scope for disputes about whether the goods conform to the specification.
The agreement should specify what happens to rejected goods. The supplier must replace or repair the rejected goods at its own cost, including the cost of return shipping. The buyer should have the right to cancel the order and recover any advance payment if the supplier cannot deliver conforming goods within a reasonable time.
Payment Terms That Protect the Buyer
The payment terms in a China supply agreement are the buyer’s primary leverage over the supplier. A buyer that pays 100% before production begins has no leverage if the goods are defective, late, or not delivered at all. The supplier already has the money.
The standard progression is a deposit with the order, a payment against the bill of lading or shipping documents, and a retention against final acceptance. A common structure is 30% with the order, 60% against shipping documents, and 10% thirty days after delivery or upon final acceptance, whichever is later.
The deposit is the supplier’s security — it covers the supplier’s material costs if the buyer cancels the order. The deposit should be proportionate to the supplier’s costs. A 30% deposit on a standard manufacturing order is typical. A higher deposit — 50% — may be required for custom products that the supplier cannot sell to another buyer if the order is cancelled.
The payment against shipping documents transfers ownership of the goods to the buyer while they’re in transit. The buyer pays when the goods are shipped, not when they’re delivered. The shipping documents — the bill of lading, the commercial invoice, the packing list, the inspection certificate — evidence that the goods have been shipped and that they passed the pre-shipment inspection.
The retention is the buyer’s security against latent defects — defects that are not apparent on delivery but appear during use. The retention is typically 5% to 10% of the contract price, payable thirty to ninety days after delivery. The supplier’s leverage to recover the retention — through negotiation, through litigation, or through a long-term business relationship — gives the buyer an incentive to resolve quality issues.
Tooling and Intellectual Property
The supply agreement should address the ownership of tooling — molds, dies, jigs, fixtures — that the buyer pays for or contributes to the production. The tooling should be identified by serial number or asset tag, physically marked as the buyer’s property, and recorded as the buyer’s asset on the supplier’s books.
The agreement should state that the tooling is the buyer’s property, that the supplier holds it as bailee, that the supplier may not use it for any purpose other than producing goods for the buyer, and that the supplier must return it to the buyer on demand or upon termination of the agreement.
The tooling clause is important because tooling disputes are common in China supplier relationships. A supplier that has the buyer’s molds and the buyer’s order volume drops — the supplier uses the molds to produce goods for other customers, or for its own brand. The tooling clause gives the buyer a contractual right to demand return of the tooling and a cause of action if the supplier refuses.
The intellectual property clause should state that the buyer retains all rights in its designs, specifications, and trademarks, and that the supplier acquires no rights in any of it. The supplier’s use of the buyer’s IP is limited to producing goods for the buyer during the term of the agreement.
A supplier that develops a manufacturing process improvement for the buyer’s product raises a question of ownership. The agreement should address this — a clause that assigns all improvements, modifications, and derivative works to the buyer protects the buyer’s position. A clause that allows the supplier to retain ownership of process improvements that are generally applicable to its manufacturing operations protects the supplier’s position. The allocation depends on the relative bargaining power of the parties.
Force Majeure and Supply Chain Risk
Chinese suppliers have become more aware of force majeure provisions since the COVID-19 pandemic, when many suppliers invoked force majeure to excuse delayed or non-delivery. The supply agreement should specify what events constitute force majeure, what notice the supplier must give, and what happens to orders that are affected by force majeure.
A force majeure clause that lists specific events — natural disaster, fire, flood, government-mandated shutdown — and excludes events that are within the supplier’s control — labor disputes, equipment breakdown, subcontractor default — is better than a general force majeure clause that the supplier can invoke in a wide range of circumstances.
The agreement should also address the buyer’s rights when the supplier’s factory is affected by force majeure. The buyer should have the right to cancel the affected orders and source from an alternative supplier. The buyer should not be required to wait indefinitely for the supplier’s force majeure event to resolve.
Governing Law and Dispute Resolution
Chinese law is the natural governing law for a supply agreement with a Chinese manufacturer. The Chinese Contract Law — now part of the Civil Code — provides a comprehensive framework for sales contracts, and Chinese courts and Chinese-seated arbitral tribunals apply it predictably.
The choice of a foreign governing law — English law, the CISG, a US state’s Uniform Commercial Code — adds complexity without necessarily producing a better result. The CISG applies automatically to contracts for the sale of goods between parties in CISG member states unless the parties opt out, and China is a CISG member. An express choice of Chinese law with an opt-out of the CISG is clearer than silence, which leaves the CISG potentially applicable.
Arbitration is generally preferred over litigation for China supply agreements. An arbitration award from a recognized institution — HKIAC, SIAC, CIETAC — is enforceable in China and in the buyer’s home jurisdiction under the New York Convention. A Chinese court judgment may not be enforceable in the buyer’s jurisdiction without a bilateral enforcement treaty.
The arbitration clause should specify the arbitral institution, the seat of arbitration, the number of arbitrators, the language of the arbitration, and the governing law. A clause that simply states “disputes shall be resolved by arbitration” without specifying the institution is defective and may be unenforceable.
