Legal Practice of OEM & OEM Contract

-----Alex Yang

Preface
With the in-depth prosecution of the Chinese reformation and opening, as well as the sustaining increase of the foreign investment, more and more international noted corporations remove their production and manufacture to China, and China is being turned into a "Big Workshop" of global industrial manufacture. For the most manufacturer of China, OEM as a mode of cooperative production prevailed overseas for many years, has been acquainted with them. There is a forecast made by an expert that China will become the global base of OEM in the near future, and China will attain the operations amount to 1-3 trillion dollars from the global market of OEM until 2005. Specially, 1/3 OEM operations of the world will be transferred to China after China acceded to WTO.

Under the said circumstance, OEM becomes a general phenomenon in manufacture field gradually, and indwells the most manufacture trades, especially the manufacture trades of home electric, hardware, lighting, playthings, costume, automobile, alcohol and foodstuff etc., as well as the IT and mobile phones which spring up recently.

In accordance with the relevant legal experience, the author will give a brief analysis regarding the legal risk and legal obstruction faced by enterprises that manufacture products through OEM in China, and introduce some noticeable questions about OEM contract.

1. A brief introduction about OEM

OEM, the abbreviation of Original Equipment Manufacturer, is the result of the social work division and the manufacture specialization. It comes into being on the principle of mutual benefits and specialized advantages. Its basic meanings is that the consignee regarding to the commission contract taps and produces the own brands of the consignor under the authorization of the consignor, and the consignor is in charge of the distribution and management of the said own brands. The mode of cooperative production such as OEM has been exercised effectively in the world for many years. In addition, there are another modes approximate to OEM such as OBM (Original Brand Manufacturer) and ODM (Original Design Manufacturer).

Popularly, OEM includes the domestic cooperation and the international cooperation. The main domestic cooperation is the cooperation between the Chinese large-scale enterprises and other small factories in China; otherwise, the Chinese enterprises usually act as the consignee process the products for those famous multinationals in the OEM international cooperation.

2. The merits and benefits of OEM

1) The merits and benefits to the consignor
Today, a lot of enterprises try to decrease the investment in permanent assets as little as possible, in order to distribute more resources to the products innovation. Many large-scale or middle-scale enterprises are unwilling to produce goods directly after they have mastered the core of manufacture and established the mature network of marketing, instead, they entrust other corporations or factories to accomplish the work of production. The advantages they will get are: a. Reduce the cost of production, so that they can increase the investment on marketing and exploring; b. Decrease the damages of equipment depreciation; c. Transfer the risk of production and manufacture; d. Make order deftly according to the requirement of market; e. Accelerate the technical renewal and the exploitation of production; f. Advance the level of management and operation, let the enterprises made a great move to the high-grade capital operation.

2) The merits and benefits to the consignee
For the lack of bankrolls, most consignees are hard to propagandize their productions on a large scale, so the sale of their productions is not good, and the awful performance of sale frustrates and influences their existence and development badly. Through the cooperation of OEM, the said enterprises may: a. Gain the opportunities of production, improve the qualities of their productions, and increase the due profits; b. Improve the level of production and manufacture; c. Avoid the disadvantages on marketing and management, on the contrary, they can utilize the advantages on specialized manufacture.

3) The merits and benefits to the society and trade
Developing OEM in the all kinds of production trades generally, can promote the specialized cooperation to a deep-seated level widely, optimize the structure of trade, and transform the swart rivalship into the benign relationship of cooperation among the enterprises in the same trade. For the numerous consumers, the direct merit of OEM is they can purchase more and more cheaper but better consumables.

3. The legal risks and questions

Despite OEM has a lot of merits and benefits, and has been accepted by numerous enterprises, there are some inevitable risks and drawbacks regarding the OEM cooperation in China at the present time.
The main problem in the international OEM cooperation is: most Chinese companies only process the productions purely and chronically for the international multinationals, and lose sight of the innovation and the development of own productions, by this means, they become the “tools” of those international multinationals gradually, and the development of national industry of China is restricted, in a way. On the aspect of domestic cooperation, the main risks and drawbacks come from the cooperative companies themselves, include the legal risks, molar risks, economic risks, brand risks and the drawbacks concerning the regulations and policies of country etc.

1) The drawbacks arise from the regulations and policies of country

OEM is a mode of cooperation selected by the enterprises voluntarily on condition that there are abundant competitions in the market. By far, OEM has not gotten the specific affirmations of policy from the governments, but baffled by some questions regarding to the regulations, stipulations and policies.

Paragraph 2 of article 27 of product quality law of the People’s Republic of China stipulates that the label of products or packs shall be true, and have the name of product as well as the name and address of the producer in Chinese. Article 9 of the provisions for product label’s labeling stipulates that the products shall have the name and address of the producer; the name and address of the producer shall be the name and address owned by the producer who has the capacity for duties and registered legally. Article 4 hereof also stipulates that the consignee shall, who processes the products for the consignor but don’t see after the selling, label the name and address of consignor onto the products.

However, article 18 of the said provisions stipulates that the products labeled by producer shall be true; and the producing area shall be labeled according to the administerial zone conception. The producing area herein shall be the last product area, process area or assemble area of the products.

This shows, the said provisions are ambiguous and self-contradictory, and induce a bad consequence directly, that is whether the enterprises of OEM label the name and address of consignor, or label the name and address of consignee, they are both likely to bear the administrative penalties.

2) The legal risks come from the contracts

The legal risks regarding the contracts exist in both OEM international cooperation and OEM domestic cooperation widely. The most important question is that the contracts and agreements made by enterprises (especially the domestic enterprises) in OEM are simple and crude, and such rough contracts make the disputes and questions arises from the course of cooperation lose the basis of settlements. Many domestic enterprises are anxious to hold the chances of cooperation and expect their products come into the market as quickly as possible, but they do not think much of the consultations or transactions prior to the cooperation, and they do not solidify the potential questions through the contracts, in this way, they will face strong legal risks in OEM.

3) The settlements

As to the said drawbacks arise from the regulations and policies of country, before the relevant departments of country adjust and regulate the said regulations and policies, the enterprises can label the consignor’s name and address in the packing of OEM products, and also label the producing area in the label of products. In order to avoid that the consumers distrust the products on account of the difference between the trade-owner’s area and the actual producing area, the consignor may adopt the method that establish the filiales in the producing area.

The most efficacious way against the legal risks of contract is that the enterprises attach more importance to the OEM contract, and achieve the contract management of OEM earnestly. During the period of OEM cooperation, the relevant enterprises entrust the qualified and seasoned law firm to manage the OEM contract is an effective method to avoid corresponding risks. Whereas the importance of the contract management of OEM, the author would like to give a brief introduction about it as follows.

4. Epilogue

In a word, as a new mode of resources share and resources conformity, the cooperation of OEM will be developed chronically on the basis of equality, mutual benefits and good faith only. The enterprises shall promote their legal consciousness, in order to make the OEM cooperation canonical, well-ordered and marketable further.

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