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China company indemnification from product defects. Yeah, whatever

by Dan Harris

American lawyers love using indemnification provisions in product manufacturing agreements. They love them so much that they often use them in China manufacturing contracts (OEM Agreements) even though they do not work well at all there.

American lawyers often put in a provision stating that if there is a product recall, the Chinese company must indemnify the American company for any fees/costs/damages incurred by the American company arising from the recall. American lawyers also often put in a provision stating that if anyone is injured by a product defect, the Chinese company must indemnify the American company for any fees/costs/damages incurred by the American company arising from the defect.

These sorts of provisions sound so good and so safe. The only problem is that they aren’t.

If a Chinese manufacturing company breaches a contract in a way that damages the American buyer, then in principle the Chinese side is liable for all damages that flow directly from such a breach. This includes the types of damages in normal indemnity provisions. It is therefore usually unnecessary to include indemnity provisions in contracts that will be enforced in China using Chinese law. For why it usually makes sense to have your manufacturing contract be enforced in China, check out China OEM Agreements. Why Ours Are In Chinese. Flat Out.

American companies are quite reasonably concerned that if their Chinese manufacturer provides them with defective products they (the American companies) could suffer liability for damages in amounts much greater than the purchase price of the product. In that situation, a claim against the Chinese manufacturer for a refund of the product price or a repair or replacement of the products is not going to come close to being sufficient to cover the damages incurred. This is very real risk in purchasing products from China.

The problem though is that you cannot expect to get a Chinese court to find a Chinese company liable for such damages. Foreign judges generally — and Chinese judges in particular — think that American courts are out of control with the damages they impose in product liability cases. So even when a Chinese manufacturer has clearly breached its contract (lead paint in children’s toys for example), Chinese courts and Chinese arbitrators typically limit the damage award to nothing more that the direct cost: a refund, a repair or a replacement, plus maybe reimbursement of penalties imposed against the American company for something like a late delivery. Chinese courts and Chinese arbitrators almost never will enter an award covering losses from product liability claims, whether those claims are made by consumers or by a government.

Usually, the best way for American companies to protect themselves from product liability and product recall claims is by securing the right insurance, with the premium costs viewed as part of the cost of doing business in China. You can try to get your Chinese manufacturer to pay your insurance premiums, but in our experience few Chinese manufacturers will agree to this and those that do will somehow raise their product pricing to cover it.

Sorry, indemnification lovers….

Dan Harris is founder of the Harris & Moure law firm, a boutique international law firm focusing on small and medium sized businesses that operate internationally. China is the fastest growing area for the firm. Dan writes as a source of China legal and business information.

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