Using a neutral local intermediary to arrange offshore manufacturing can be a sensible option, but does not necessarily avoid all risk.
An Auckland medical devices supplier commission a batch of components to be manufactured in China. As the Auckland company was not experienced with this type of project, a deal with a factory in Guang Zhou was done through a Hong Kong intermediary agency. When fitted to the medical devices, the components were found to be faulty and unusable.
The company had already paid out NZD30,000 and wanted their money back. But where to start? A major stumbling block was the absence of contractual relations between the Auckland company and the Guangzhou manufacturer. There was a contract between the Hong Kong intermediary and the Chinese manufacturer, but no ability for the New Zealand company to claim breach contract directly against the manufacturer.
In these circumstances, proceeding with a convoluted claim via the intermediary would have been prohibitively expensive, and the Auckland company decided to cut its losses. An amount like $30,000 doesn’t go a long way in international litigation, but would have been be a big hit to the business’s bottom line.
There are many benefits in using English-speaking offshore intermediaries who understand the languages and cultures of Asian manufacturing powerhouses such as Southern China, Vietnam and Thailand.
Familiarity with the markets and the ability to assess a manufacturer’s ability to meet requirements is also invaluable, especially for more technical products, and some agents also specialise in dealing with complex categories.
A good local intermediary can provide essential support in the early stages until the supplier and manufacturer are ready to work face to face. They can also be a useful ear to the ground for the supplier.
However offshore manufacturing is an area where disputes, breaches of contract, and problems of enforcement commonly occur. These problems can be exacerbated where the contract is set up by an intermediary on behalf of a trusting overseas principal.
For a lower value contract, it may not make sense for a business to spend money on legal protection just in case things go wrong, and instead the business may rely on insurance cover. Unfortunately, insurers may not be impressed with lack of due diligence and may not want to pay out. Consequential losses such as breach of contract with customers, loss of preferred supplier status, or breach of the business’s financial covenants may add to the business’s exposure.
So how should businesses protect themselves in this type of situation? Here are some points to be considered:
- Don’t accept the contract offered at face value – it will be drafted to protect the interests of the intermediary and manufacturer, rather than the ultimate purchaser.
- Ensure there is a direct contractual link to the manufacturer or other parties who are supplying goods or services.
- Obtain financial profiles of your counterparties in advance if possible.
- Use Incoterms (international commerce terms*) in the contract as these are universally understood and accepted.
- Consider incorporating a liquidated damages clause in the contract with clearly defined events of breach.
- Insist that any security bond be held in trust by an independent third party.
- Arbitration in an overseas jurisdiction under the foreign law may realistically be the most effective way to enforce the contract.
- Be aware of potential threats to intellectual property rights from overseas business partners. These can range from retaining and selling product over-runs to registering brands which don’t belong to them.
Anyone involved in offshore manufacturing at any level would be well advised to maintain an adequate fighting fund and a good understanding of the local legal processes.