Many companies start outsourcing their products from China using a broker/sourcing agent. Tomes have been written about the pros and the cons of using a sourcing agent versus dealing directly with a Chinese manufacturer and I have no intention of rehashing all that here. My relatively succinct and simple and mostly unhelpful view is as follows:
About 45 percent of all sourcing agents are corrupt. About 45 percent of all sourcing agents are incompetent/worthless. About 10 percent of all sourcing agents are invaluable.
I cannot tell you how many times a client has retained one of our China lawyers to assist in making the switch from using a sourcing agent to going direct with a brand new and far cheaper factory only to have the old factory tell our client it can now reduce its prices by 30-40 percent because it will no longer need to kickback 30 to 40 percent to the sourcing agent. I also cannot tell you how many times a client or a potential client has given us some completely invalid reason as to why their sourcing agent is so clearly different from the rest. We commonly hear that such and such sourcing agent must be good and honest because it is being used by some competitor or because it has an office in the United States. If only it were that clear-cut.
One of the legal issues we often must resolve is whether our client who is using a sourcing agent would be better off contracting with that sourcing agent for the manufacturing of its product, or contracting directly with the Chinese factory, while still paying the sourcing agent for its services. One of our China lawyers recently explained to a client some of the things the client should consider in determining whether to contract with its sourcing agent or to contract directly with its Chinese manufacturer, as per the below, with any identifiers stripped off:
You raise the usual and standard issues related to this kind of contract. To start, it makes no sense to have essentially the same a contract with two parties. You must choose with whom you are going to contract. Will it be your sourcing agent or will it be the Chinese factory? You must contract with the entity that will issue the invoice for the product and in this case (unless we change things), that is your sourcing agent. But if you contract with your sourcing agent, you can and you should also have a contract with the Chinese factory that deals with issues like ownership of intellectual property, ownership and control of the materials, non-circumvention and non-compete and similar. See China NNN Agreements. However, many Chinese factories are not willing to enter into that kind of contract if they are not the direct seller of the product.
The old way was to enter a contract with the sourcing agent, loading all of the liability on it. Since Sourcing Company X is a U.S. company, operating in this way is pretty much just like making a purchase from any U.S. company that outsources its manufacturing around the world. The question is: can Sourcing Company X perform? Does it have the resources to do the work and the asset base to deal with any problems?
As you have figured out, there can be many problems with the “old way.” If you are purchasing from a huge company like Apple, you don’t really care about who their ultimate suppliers are because you know Apple will do the work and you know Apple will stand behind the products and has the resources to handle pretty much anything that can go wrong. For a small company like Sourcing Company X, your analysis is quite different and is more difficult.
There are two issues: First, what happens when everything goes right? If Sourcing Company X takes care of everything, then using them makes sense. Many companies fail to consider what happens when things go right. If you end up doing all the work in China, why bother with Sourcing Company X.
Second, what happens when things go wrong? As you know, things going wrong is standard operating procedure for China manufacturing. If there is a defect, can you rely on Sourcing Company X to fix things? If there is a late delivery or a short delivery, can you rely on Sourcing Company X to address this in a way that does not require your staff travel to China? Can Sourcing Company X ensure that the fabrics and other materials are properly processed and securely stored and maintained in China in a situation where you have no direct contract with the China factory? What if the China factory goes bankrupt: what happens to the materials then? Will Sourcing Company X remain liable in that situation? Can Sourcing Company X ensure all payments will be made to the factory and to the suppliers of the factory? Can Sourcing Company X ensure that the Chinese factory and its suppliers and the suppliers to its suppliers will not steal your IP or circumvent you by going directly to your customers? If circumvention happens, will Sourcing Company X aggressively take care of the issue and does it have the financial resources to cover for liability?
On these issues, if you conclude that the answer is yes in each case, then you should contract with Sourcing Company X. The more difficult situation is if you conclude that Sourcing Company X may not be fully able to deal with these issues. In that situation, you then have to consider whether you are better off with a contract with a Chinese company that will require you to litigate in a Chinese court to deal with the issues or better off with Sourcing Company X here in the U.S. and insured here as well. See also China Contracts, But With Whom?
As you can see, the matter is complex. In my experience, I find large companies with a presence in China prefer to contract directly with the Chinese factories. And this is the modern trend. However, smaller companies that do not have the time or the people on the ground in China still often use companies like Sourcing Company X to secure their products from China. The problem with companies like Sourcing Company X is they often refuse to enter into a reasonable contract. If Sourcing Company X is willing to enter into a reasonable contract, that is one matter resolved in its favor.
We have to assess two issues: a) can Sourcing Company X really perform and b) if you contract with a single Chinese factory, does that really put you into a better position if something goes wrong. You will need to make this decision based on your own business judgment, since you are the one with direct contact with the players. We can help you with this by conducting due diligence/background checks on the two companies.
Please let me know if you need more information from me on this matter.
This article was written by Dan Harris and published on China Law Blog. Original Post: http://www.chinalawblog.com/2017/09/china-manufacturing-to-broker-or-not-to-broker-that-is-the-question.html