By Kevin Lee
Misunderstanding, confusion, and uncertainty can definitely plague your entire supply chain when you choose to outsource from abroad, especially when dealing with an alien culture like China. Chinese suppliers deal in a different language and under different laws than everyone else on the western hemisphere. So, in your dealings with Chinese suppliers, you should always strive to have a clear and concise agreement.
Types of export contracts:
When importing, in general, there are several ways you and your overseas partner could come to an agreement:
- Telephonic: You could set out the terms of a deal over the phone. This sort of agreement is rare unless both parties have had prior dealings with each other and trust one another.
- Quotation: Another form of agreement is for the supplier to send you a quotation, followed by you sending that quotation back along with your written consent.
- Performa invoice: Instead of a quotation, a supplier may send you a Performa invoice, which also requires your written consent. However, using a Performa invoice is more common than using a quotation. Moreover, a lot of the time, a Performa invoice becomes handy when you want to pass your products through customs.
- A formally written contract: The best option is for all the parties involved to sign a formally contract detailing all the duties and obligations of the included parties.
What makes a formal contract the best option?
You and your supplier are best served by a formal contract. Here are 10 reasons why a written formal contract is preferable to any of the other alternatives:
- Resolving disputes:
In business, as in life, disagreements are bound to appear, which is why you need to have a contract to refer to.
You and your Chinese supplier just can’t seem to agree on what constitutes an act of God (otherwise known as Force Majeur)? A well-defined contract can help you with that.
Unclear on who is supposed to be responsible for the products once they’re in international waters? Your contract will answer that.
The worst case scenario is that the dispute revolves around something outside of the bounds of the contract. In that case, the contract will specify how both parties should move forward: negotiation, arbitration, or litigation.
When it comes to arbitration, the contract will dictate who will be the arbiter and where the arbitration will take place.
As for litigation, the contract let’s all the parties involved know which country’s law is in effect.
- Offering certainty when things go wrong:
Sometimes, the problem isn’t that you disagree with your supplier but is that the process has reached an impasse, leaving you and the supplier uncertain about your next step.
For example, suppose that as the truck carrying the products was on its way to the port in Shenzhen, China and crashed. The result was a total loss of your product. Not only will the contract define which party should be held liable, but it will also identify what are the next steps to be taken.
Without a written agreement that tries to cover every contingency, you and your supplier will inevitably run into scenarios that will slow the entire process and sow confusion.
- Specifying terms:
In a contract, the parties agree to both the amount of money to be paid and the schedule of said payment. The amount of money to be paid is the total contract value; it is the price of the products, commissions involved, taxes, shipment, and any other fees.
It is also very important to agree to the payment schedule. The payment schedule defines how much the deposit will be, when the rest of the money will be paid, and how much money will be withheld till product testing.
When working with a Chinese supplier, placing a deposit can make the supplier feel more at ease, hence prompting him to give you more of a priority, especially during those busy seasons.
- Setting clear product specifications that can help you and the supplier avoid calamitous misunderstandings:
You and your supplier can avoid plenty of quality problems that might affect product design, materials used, components, colors, and other specifications of your products. There are several reasons you should trust a written contract over any other kind of contract when it comes to clearing misunderstandings:
- Using only e-mails, phone calls, or even skype to seal a deal can lead to the loss of significant specifications.
- Although sales managers will do everything in their power to get your business, at the end of the day, the sales managers aren’t fully aware of all the technical aspects related to your products. As a result, it isn’t that farfetched to realize that a sales manager may have promised you something that your supplier can not deliver on.
- You need to bear in mind that any specifications defined will automatically be filled in by your supplier. So, unless you are willing to roll the dice, you cannot afford to leave anything up to your supplier.
- Occasionally, you will need products that meet certain standards and criteria. When that happens, you should inform your supplier from the very beginning. Or else, your supplier will automatically start to fill your order, and odds are the products won’t comply with the standards.
- Facilitating third party contracts:
Any and all third party contracts are built upon the terms in the export contract, making the export contract all the more valuable. A lot of third party contracts are used to mitigate the risk shouldered by one or both parties.
When it comes to your supplier, the more you assure him of his due payment, the more you set his mind at ease, and the higher priority your supplier will give you. We already mentioned using deposits in the payment terms section.
However, another tool you can resort to is different forms of insurance and guarantee, such as bank letters of guarantee and bank letters of credit.
For example, a bank letter of guarantee is sort of your bank vouching for you, saying that in the event of you not paying the supplier, the bank will in your stead.
- Avoid delays:
When forging the contract with your supplier, including a “late delivery clause” can be an excellent way for you to protect yourself against upsets to your schedule and to increase the chance that your supplier will always keep you at the top of their lists.
A “late deliver clause” is an agreement where should the supplier fail to deliver on time, a percentage is taken out from his final paycheck. Furthermore, with each passing day that your supplier doesn’t deliver, you get to deduct more money from his final balance. Naturally, you should give your supplier some leeway; the convention is to give suppliers seven days after the delivery date before the deductions start.
- Addressing products that don’t meet the agreed upon standards:
In the event of the products not passing inspection, the contract should set compensation terms, which simply means a deduction in the final balance payment. This will pressure your supplier into being more honest with you.
This practice is encouraged for a couple of reasons:
- It is quite possible that, in order to outbid its competitors, your Chinese supplier was planning to use cheap materials or to resort to any other cost cutting mechanism.
- As mentioned earlier, sales managers are rarely aware of the technical aspects of the business. Therefore, it is not strange for a sales manager to promise you a higher level of quality than the supplier is actually able to produce.
Maybe you have placed a small quantity order for testing before this big order. But, the best way to address these problems is to let your supplier know right off the bat that a reduction in quality will not be tolerated. Otherwise, the supplier will lose money.
The contract should detail the following:
- Unacceptable defects and damages
- The amount of money that will be deducted should a problem with the quality appear.
- The liability of the supplier if the products fail testing completely.
Obviously, for this part of the contract to be actionable, you can’t pay your supplier in full until you’ve tested the products. Moreover, it should be made clear to your supplier that he can demand the final balance payment once everything is good and well on your side.
- Specifying the conditions for contract cancellation:
It is quite possible that either one of the parties involved in an export contract, or even both, want to back out of the deal. This could be due to a multiple of reasons. Nevertheless, there needs to be a structure for a pullout.
If your supplier pulls out in the last minute, he should be liable for the damages he causes you. But, if your supplier pulls out due to external circumstances, then, depending on these circumstances, your supplier might be entitled to a lightened punishment. The same goes for you.
Without a contract to specify the cancellation policy for both parties, this area can quickly turn into a minefield.
- Protecting confidentiality and intellectual property:
When you work with a supplier, you are effectively taking on a business partner with whom you share plenty of trade secrets. In addition, it is entirely conceivable that one party depends on the intellectual property of the other to do its job; either the products you purchase are based off of the intellectual property of your supplier, or your supplier builds products according to your unique and proprietary designs.
The benefit of a contract is to protect all the parties involved along with their assets, while giving out the necessary licenses of usage. More interestingly, there is the possibility that your supplier relies on the intellectual property of a third party, in which case your supplier might be obligated to pass those rights on to you in the contract.
- Showing seriousness about the business:
For a supplier to respect your business and take you seriously, you must do everything in your power to convey your absolute commitment to the job at the hand.
Trying to deal with your supplier using kid gloves so as not to offend your supplier will have the opposite effect; you will come across as disorganized.
When it’s time to deal, don’t be afraid to demand using a contract.
It is quite normal that, despite your best efforts, your interactions with your supplier get hectic from time to time. No contract can eliminate all the problems existing in international trade. But a contract can significantly reduce the possibility of those problems arising.
Kevin Lee is the co-founder of Asianconn, a China-based souricng agency. He writes about global sourcing trends and advise for purchasers and importers on asianconn.com. Kevin has been living full time in Shanghai, China, since 2003. For further questions, you can contact him at firstname.lastname@example.org.