Problems with Intermediary Contracts

Using a neutral intermediary to arrange offshore manufacturing can be a sensible option, but does not necessarily avoid all risk.

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An Auckland-based supplier of medical devices wanted to commission the manufacturing of a batch of components in China. As the company was not experienced with this type of project, a deal with a factory in Guangzhou was arranged through a Hong Kong intermediary agency.

The components were made, but when fitted to the medical devices they were found to be faulty, rendering them unusable. The company had already paid out $30,000 New Zealand dollars and wanted their money back! However, 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 in breach of 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 in the neighbourhood of $30,000 doesn’t go a long way in international litigation, but would have been a big hit to the business’s bottom line.

There are many benefits for Kiwi businesses in using English-speaking offshore intermediaries who understand the languages and cultures of Asian manufacturing powerhouses such as Southern China, Vietnam and Thailand.

Their familiarity with these markets and ability to assess whether a manufacturer can meet requirements is also invaluable, especially for more technical products, and some agents also specialise in dealing with complex product 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 provide 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 independently of the 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 consider:

  1. Don’t accept the draft contract at face value – it will be drafted to protect the interests of the intermediary and manufacturer, rather than the ultimate purchaser.
  2. Ensure there is a direct link to sue the manufacturer or other parties who are supplying goods or services.
  3. Obtain financial profiles of counterparties in advance of committing to the deal.
  4. Use Incoterms (international commerce terms) where possible as these are universally understood and accepted.
  5. Consider including a liquidated damages clause with clearly defined events of breach.
  6. Insist that any performance or security bond be held in trust by an independent third party.
  7. Accept that arbitration in the overseas jurisdiction may realistically be the most effective way to enforce the contract, to avoid the problem of recognition of foreign judgments or awards.
  8. Be aware of potential threats to intellectual property rights from overseas business partners. These can range from copying designs, retaining and selling product overruns, to registering brands which don’t belong to them.

Anyone involved in offshore manufacturing would be well advised to maintain an adequate fighting fund and a good understanding of the local legal processes.

This article is intended to provide general information and comment, and should not be relied upon as a substitute for specific legal advice. If you have any questions or would like further information, please feel free to get in touch with us at info@battersby.co.nz.

Contributed by Mike Battersby, Lucy Xie and Jennifer Shi of Battersby and Co Business Lawyers.

One Comment

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