A foreign company that sources products from Chinese suppliers needs a supplier agreement that works in China. An agreement that works in the foreign company’s home jurisdiction — common law drafting, broad remedies, the assumption that the parties will litigate disputes — may not work in China, where the legal system, the enforcement environment, and the commercial practices are different.
The agreement is not only a legal document — it’s a commercial tool that defines the relationship, sets expectations, and gives the foreign buyer leverage when things go wrong. Here’s how to structure the key provisions of a China supplier agreement.
The Supplier Profile: Know Who You’re Dealing With
Before drafting the agreement, the foreign buyer should know who the supplier is. The supplier’s business license provides basic information — the company’s legal name, its registered address, its legal representative, its registered capital, and its business scope. The business license is a public document that can be verified through the National Enterprise Credit Information Publicity System, an online database maintained by the Chinese government.
The business license verification confirms that the supplier exists and is legally qualified to conduct the business it’s offering to conduct. A supplier whose business license doesn’t include the product category that the buyer is purchasing is operating beyond its permitted business scope — a red flag.
The business license also shows the registered capital — the amount of money that the shareholders committed to the company. A supplier with registered capital of 100,000 RMB is a small company with limited financial resources. A supplier with registered capital of 10 million RMB has more substantial backing. The registered capital is not a guarantee, but it’s an indicator of the supplier’s financial commitment to the business.
The supplier’s export license — if the goods are for export — confirms that the supplier is authorized to export the specific products. An export license is required for certain products — food, medical devices, chemicals, products subject to export restrictions — and the buyer should confirm that the supplier has it.
The Product Specification
The product specification is the most important part of the agreement from a quality perspective. The specification must define the product with enough precision that an independent inspector can determine whether a shipment meets the specification. A specification that says “high quality” or “first grade” or “meets international standards” is not a specification — it’s a statement of aspiration.
The specification should include the physical dimensions — the length, width, height, weight, tolerance — the material composition — the grade of steel, the type of plastic, the composition of the chemical — the functional performance — the strength, the durability, the operating parameters — and the appearance — the color, the finish, the labeling. A drawing, a photograph, and a physical reference sample — kept by both parties and signed by both parties — supplement the written specification.
The specification should include the packaging requirement — the packaging material, the packaging method, the labeling on the packaging, the bar code or QR code, the shipping marks. Packaging that’s inadequate for the transportation route — a container ship that takes four weeks from Shanghai to Rotterdam, with multiple handling steps — results in damaged goods at destination, and the damage is a specification failure, not a shipping problem.
The specification should reference the technical standard — the Chinese national standard, the industry standard, the international standard — that the product must meet. A product that must meet a specific Chinese GB standard should reference the standard number in the specification. A product that must meet an international ISO standard should reference the ISO standard number.
The Quality Control Regime
The agreement should establish the quality control points during production. The first control point is the pre-production sample — a sample manufactured before mass production begins, using the production tooling and the production materials, that the buyer approves before the supplier proceeds to mass production. The pre-production sample is the physical standard against which the mass-produced goods are compared.
The second control point is the in-process inspection — an inspection during production, when a portion of the goods has been produced but the production run is not complete. The in-process inspection identifies quality problems before the entire production run is completed, giving the supplier the opportunity to correct the problem and the buyer the confidence that the correction is being made.
The third control point is the pre-shipment inspection — an inspection after production is complete and before the goods are shipped. The pre-shipment inspection is the most common inspection, and it’s the buyer’s last opportunity to stop a defective shipment before it leaves China. A buyer that conducts pre-shipment inspection and rejects a defective shipment incurs delay but not the cost of shipping defective goods to the destination country.
The inspection standard should be the Acceptable Quality Level — the AQL — which is a statistical sampling standard that defines the maximum number of defective units that are acceptable in a given sample size. An AQL of 2.5 — a common standard for consumer goods — means that a sample of 200 units can have up to 10 defective units. The AQL should be specified in the agreement, together with the inspection level — the sample size relative to the production lot size.
The agreement should state what happens when the inspection fails. A failed inspection should give the buyer the right to reject the shipment, to require the supplier to rework the shipment at the supplier’s cost, or to accept the shipment at a reduced price. The supplier who is required to rework a rejected shipment and can’t ship on time is in breach of the delivery obligation and subject to the delay consequences.
The Payment Terms
The payment terms in a China supplier agreement are typically structured to balance the supplier’s need for working capital with the buyer’s need for leverage. The most common structure is a deposit with the order — typically 30% — and the balance against shipment documents or after delivery.
A 30% deposit paid with the order gives the supplier the working capital to buy materials and start production. The deposit is the buyer’s risk — if the supplier doesn’t produce the goods, the buyer must recover the deposit. The risk is reduced by conducting due diligence on the supplier before placing the order — business license verification, factory visit, reference check — and by placing the deposit with a supplier that the buyer has successfully dealt with before.
The balance payment is due against shipment documents — the bill of lading, the commercial invoice, the packing list, the certificate of origin — or after delivery of the goods to the buyer. Payment against documents gives the supplier the assurance that the buyer will pay once the goods are shipped, and the buyer the assurance that the goods have been shipped before payment is made. Payment after delivery gives the buyer the maximum leverage — the goods are in the buyer’s possession before payment — but the maximum working capital benefit is to the buyer at the supplier’s expense.
A letter of credit is a payment mechanism that provides payment security to both parties. The buyer opens a letter of credit at its bank, and the supplier presents the shipment documents to the bank and receives payment. The letter of credit transfers the payment risk from the supplier to the bank — the buyer’s bank pays, not the buyer — and the supplier receives payment as soon as the documents are presented and found to comply with the letter of credit terms. The letter of credit cost is borne by the buyer — the bank charges a fee for issuing the letter of credit — and the letter of credit adds administrative complexity that a small supplier may not want to deal with.
The letter of credit is most appropriate for a first transaction with a new supplier or for a large transaction where the buyer’s creditworthiness is not established. For an ongoing relationship with a trusted supplier, a telegraphic transfer — a wire transfer — against documents is more common and less expensive.
The Delivery Terms
The delivery terms should be specified using the Incoterms — the International Commercial Terms — that define the responsibilities and the risk allocation between the buyer and the supplier for the transportation of the goods. The most common Incoterms for China exports are FOB — Free on Board — and CIF — Cost, Insurance, and Freight.
Under FOB, the supplier is responsible for delivering the goods to the port of departure and loading them on the vessel nominated by the buyer. The risk of loss or damage to the goods passes from the supplier to the buyer when the goods are on board the vessel. The buyer is responsible for the ocean freight, the insurance, and the import clearance at the destination. FOB gives the buyer control over the shipping — the buyer nominates the shipping line and the freight forwarder — and the buyer pays the freight directly.
Under CIF, the supplier is responsible for the goods until they arrive at the port of destination. The supplier arranges the ocean freight and the insurance, and the cost of freight and insurance is included in the price. The buyer takes delivery at the destination port and is responsible for the import clearance. CIF gives the supplier control over the shipping — which may be more convenient for the supplier — and gives the buyer a delivered price that includes the cost of the goods and the cost of transportation.
The Incoterms are supplemented by the delivery date or the delivery window — the date by which, or the period within which, the supplier must deliver the goods to the buyer or to the carrier. A delivery date that’s defined as a specific date gives the supplier a clear target. A delivery window — “within eight weeks of receipt of the deposit” — gives the supplier flexibility and the buyer less certainty. A delay in delivery that exceeds a specified number of days — typically 14 or 21 — gives the buyer the right to cancel the order and recover the deposit.
The Intellectual Property Protection
A foreign company that provides specifications, designs, tooling, or technical information to a Chinese supplier is sharing its intellectual property. The supplier agreement should include a confidentiality clause that restricts the supplier’s use of the buyer’s technical information to the performance of the agreement and prohibits the supplier from using the information for any other purpose.
The agreement should also address the ownership of IP that results from the supplier’s work. The general rule should be that all IP created by the supplier in the performance of the agreement — modifications to the design, improvements to the production process — belongs to the buyer. This rule prevents the supplier from taking the buyer’s design, modifying it slightly, and claiming that the modified design belongs to the supplier and can be sold to the buyer’s competitors.
The IP clause in a China supplier agreement is harder to enforce than a similar clause in a Western jurisdiction because Chinese IP enforcement — while improving — is not as developed as the enforcement environment in the United States or Western Europe. The clause is still valuable — it establishes the contractual obligation that can be enforced in a Chinese court or in arbitration, and it supports a claim for breach of contract and damages.
The Dispute Resolution Clause
The dispute resolution clause should specify the method of resolving disputes — litigation in a Chinese court or arbitration — and the governing law. Chinese law is the natural governing law for a contract with a Chinese supplier that’s performed in China. Applying a foreign law to a Chinese supplier creates disputes about what the law actually requires and how it should be interpreted, and a Chinese court or a Chinese arbitration tribunal is more comfortable applying Chinese law than a foreign law.
Arbitration is generally preferred over litigation for international supply agreements because the arbitration award is enforceable under the New York Convention — to which China is a party — in the buyer’s home jurisdiction. A Chinese court judgment is not automatically enforceable in a foreign jurisdiction — the buyer must bring a separate proceeding in the foreign court to enforce the Chinese judgment. An arbitration award is directly enforceable in the foreign jurisdiction under the New York Convention, subject to limited defenses.
The arbitration institution should be a reputable Chinese arbitration institution — the China International Economic and Trade Arbitration Commission, CIETAC, or the Shanghai International Arbitration Center, SHIAC — or an international arbitration institution that has experience with China-related disputes — the Hong Kong International Arbitration Centre, the Singapore International Arbitration Centre. The seat of arbitration and the language of arbitration should also be specified.
