Legal regulations and important considerations regarding manufacturing processing contracts

In today’s manufacturing and business activities, manufacturing processing contracts are a common arrangement that enables enterprises to optimize costs and enhance production efficiency. However, without a proper understanding of the applicable legal regulations and main considerations during contract execution, enterprises may face significant legal risks and disputes.

I. Current situation relating to manufacturing processing contracts

At present, manufacturing processing contracts are widely utilized across various industries to reduce costs, leverage production capacity, and flexibly expand business operations.

In practice, many contracts are drafted in a cursory manner, lacking clear provisions on product quality, performance schedules, ownership rights, and liability for breaches, thereby leading to numerous disputes. Such a reality highlights the necessity for enterprises to accurately understand and strictly comply with legal regulations governing manufacturing processing contracts in order to safeguard the lawful rights and interests of all parties involved.

II. Concept of a manufacturing processing contract

1. What is a manufacturing processing contract?

Pursuant to Article 542 of the Civil Code 2015, a processing contract is an agreement between parties whereby:

• The processor performs work to create a product in accordance with the requirements of the ordering party;
• The ordering party receives the product and pays the processing fee as agreed.

Accordingly, a manufacturing processing contract is an agreement between a principal and a processor in the manufacturing sector, whereby the processor organizes and conducts production activities to manufacture products in accordance with the designs, technical specifications, quantity, quality standards, and production schedule required by the principal; and the principal is responsible for receiving the products and paying the agreed processing fees in accordance with the executed contract.

2. Can a manufacturing processing contract be entered into between a domestic enterprise and a foreign enterprise?

A manufacturing processing contract may be validly entered into between a domestic enterprise and a foreign enterprise. In such cases, the contract is regarded as commercial processing and is governed by the Commercial Law 2005.

Specifically, under Article 178 of the Commercial Law 2005, commercial processing is a commercial activity whereby the processor uses part or all of the raw materials or materials supplied by the principal to perform one or more stages of the manufacturing process according to the principal’s requirements in exchange for remuneration. Furthermore, Article 179 of the Commercial Law 2005 requires processing contracts to be made in writing or in another form having equivalent legal validity.

3. What types of products are commonly manufactured under manufacturing processing contracts?

Pursuant to Clause 1 Article 180 of the Commercial Law 2005, “all types of goods may be processed, except those prohibited from business operations”. Accordingly, as a general principle, manufacturing processing contracts may be applied to most categories of products, provided that such products are not included in the list of goods prohibited by law.

• Garments, footwear, and handbags;
• Electronic components and electrical/electronic equipment;
• Mechanical, metal, plastic, and rubber products;
• Packaging products, consumer goods, and construction materials;
• Processed food products (subject to compliance with food safety regulations under specialized laws).

For processing activities conducted for foreign traders, Clause 2 Article 180 of the Commercial Law 2005 stipulates that goods prohibited from business operations, export, or import may only be processed upon approval from the competent state authority.

III. Legal regulations governing manufacturing processing contracts

1. How does current legislation regulate manufacturing processing contracts?

- Application of the Civil Code 2015

• Pursuant to Article 542 of the Civil Code 2015, a processing contract is an agreement whereby the processor performs work to create a product according to the requirements of the ordering party, and the ordering party is obligated to receive the product and pay the processing fee.
• Articles 542 through 553 of the Civil Code 2015 comprehensively regulate processing contracts, including contractual subject matter, rights and obligations of the parties, allocation of risks, product delivery and acceptance, contract termination, and payment obligations.
• If a manufacturing processing contract is entered into between individuals or organizations for non-profit purposes, or if at least one party is not a trader, such contract is classified as a civil contract and governed by the Civil Code 2015.

- Application of the Commercial Law 2005

• Pursuant to Article 178 of the Commercial Law 2005, commercial processing constitutes a profit-generating commercial activity. Therefore, if a manufacturing processing contract is entered into between traders or serves commercial business activities, it is regarded as a commercial processing contract and governed by the Commercial Law 2005.
• Articles 179 through 184 of the Commercial Law 2005 provide regulations concerning contractual form, processed goods, rights and obligations of the parties, processing remuneration, and technology transfer in processing arrangements involving foreign organizations and individuals.

2. What contents must be included in a manufacturing processing contract under current law?

• Information of the Contracting Parties: Pursuant to Articles 385 and 398 of the Civil Code 2015, the contract must clearly identify the contracting parties, including their names, addresses, lawful representatives, basis of representation, and contact information of both the principal and the processor.
• Subject matter of the manufacturing processing contract: Under Article 543 of the Civil Code 2015, the subject matter of a processing contract is the product to be created according to the principal’s requirements and predetermined designs, standards, or technical specifications. The contract should clearly specify the product type, specifications, quantity, and quality standards.
• Materials used for processing: Pursuant to Clause 1 Article 544 and Clause 1 Article 546 of the Civil Code 2015, the contract should clearly state which party is responsible for supplying materials, their quantity and quality, delivery schedules, storage responsibilities, and the handling of surplus materials after contract completion.
• Rights and obligations of the parties: According to Articles 544 through 547 of the Civil Code 2015, the contract should comprehensively set out the rights and obligations of both the principal and the processor, including obligations relating to product delivery and acceptance, implementation instructions, confidentiality, and responsibility for product quality.
• Processing fees and payment method: Pursuant to Article 552 of the Civil Code 2015, the contract should specify the processing fee, payment method, and payment schedule. In the absence of an agreement, the average processing fee prevailing at the place and time of payment shall apply.
• Performance period and product delivery: According to Articles 549 and 550 of the Civil Code 2015, the contract should clearly determine the processing period, the time and place of product delivery and acceptance, and legal liability in the case of delayed delivery or acceptance.
• Liability for breach of contract: Pursuant to Articles 351 and 418 of the Civil Code 2015, the contract should clearly stipulate the remedies applicable in the case of a breach, including contractual sanctions, damages, and the right to unilaterally terminate the contract.
• Form of Contract: Under Article 179 of the Commercial Law 2005, commercial processing contracts must be executed in writing or in another form having equivalent legal validity.

3. Is there a statutory maximum or minimum term for the performance of a manufacturing processing contract?

Current legislation does not prescribe any mandatory maximum or minimum duration for a manufacturing processing contract. The contract term is determined by the mutual agreement of the parties based on production needs and performance capabilities.

• Principle of freedom of contract: Pursuant to Article 385 of the Civil Code 2015, parties are free to agree upon the contents of a contract, including the performance period, provided that such agreement does not violate prohibitory provisions of law or contravene social ethics.
• Regulations on contract effectiveness and duration: Under Article 401 of the Civil Code 2015, a contract becomes effective from the time of its conclusion unless otherwise agreed by the parties or prescribed by law.
• Legal liability for delay: Pursuant to Articles 549 and 550 of the Civil Code 2015, where the processor delays product delivery, the principal may grant an extension. If the processor still fails to complete performance within the extended period, the principal may unilaterally terminate the contract and claim damages. Conversely, where the principal delays acceptance of the products, the processor may deposit the products with a third party for safekeeping and require the principal to take the resulting expenses.

4. How is legal liability for breaches of a manufacturing processing contract regulated?

• Specific performance: Pursuant to Article 351 of the Civil Code 2015, a party that breaches its obligations must continue to perform the agreed obligations, unless performance has become impossible or the parties have agreed otherwise.
• Contractual sanctions: According to Article 418 of the Civil Code 2015 and Article 300 of the Commercial Law 2005, contractual sanctions may only be imposed if expressly agreed upon by the parties.
• Compensation for damages: The breaching party must compensate for actual and direct damages resulting from the breach, including material losses and profits that the non-breaching party would otherwise have earned in the absence of the breach, in accordance with Articles 351, 360, and 419 of the Civil Code 2015.
• Unilateral termination or cancellation of contract: In cases involving a serious breach of contractual obligations or other circumstances prescribed by law, the non-breaching party may unilaterally terminate performance of the contract or cancel the contract and claim damages under Articles 422 and 551 of the Civil Code 2015.

IV. Questions relating to manufacturing processing contracts

1. Does the principal have the right to request changes to the production schedule?

The principal’s right to request modifications to the production schedule depends on the contractual agreement and the provisions of the Civil Code 2015, specifically as follows:

• Pursuant to Clause 2 Article 544 of the Civil Code 2015, the principal has the right to instruct the processor in the performance of the contract. On that basis, the principal may request adjustments to the production schedule, provided that such requests do not conflict with the agreed contractual terms.
• However, under Clause 2 Article 547 of the Civil Code 2015, the processor has the right to refuse unreasonable instructions if the proposed changes to the production schedule may reduce product quality or result in unreasonable additional costs, provided that the processor promptly notifies the principal thereof.
• Where changes to the production schedule materially affect the performance period, costs, or other essential contractual terms, the parties must agree on amendments or supplements to the contract in accordance with Articles 385 and 401 of the Civil Code 2015.

2. Is it permissible to include multiple product categories within a single manufacturing processing contract?

Pursuant to Article 385 of the Civil Code 2015, contracts are established on the basis of the parties’ freedom of contract and voluntary agreement. Accordingly, the parties may agree to process one or multiple types of products under the same contract.

However, under Articles 542 and 543 of the Civil Code 2015, the subject matter of a processing contract must be clearly identified according to predetermined designs and standards. Therefore, where multiple products are processed under the same contract, each product type must be separately described in terms of design, specifications, technical standards, quantity, quality requirements, and performance timeline.

If the manufacturing processing contract falls within the scope of commercial processing activities, the contract must still satisfy the written-form requirement prescribed under Article 179 of the Commercial Law 2005.

3. May a processor enter into a subcontract with a third party?

Pursuant to Article 283 of the Civil Code 2015, an obligor may authorize a third party to perform its obligations if the obligee consents or if such arrangement is not prohibited by law.

With respect to processing contracts, Article 546 of the Civil Code 2015 provides that the processor remains directly responsible for the quality of the products. Therefore, even if a subcontract is entered into with a third party, the processor remains fully liable to the principal for the production schedule, product quality, and all obligations undertaken under the contract.

If the manufacturing processing contract constitutes commercial processing, subcontracting may only be implemented if expressly permitted under the primary processing contract or approved by the principal, thereby ensuring effective quality control and protection of intellectual property rights.

4. If the principal delays payment, does the processor have the right to suspend production?

During the performance of a manufacturing processing contract, delayed payment of processing fees by the principal is a common occurrence and may directly affect the processor’s production activities. The law permits the processor to suspend performance in certain circumstances.

- Payment obligation of the principal: Pursuant to Clause 1 Article 552 of the Civil Code 2015, the principal is obligated to pay the processing fee in full and on time as agreed. In the absence of a different agreement, payment must be made upon receipt of the products.

- Right to suspend performance when the other party is in breach: Under Article 351 of the Civil Code 2015, where one party breaches its obligations, the other party may suspend the performance of its own obligations if continued performance would cause damage, unless otherwise agreed.

- Conditions for suspending production: The suspension of production is considered lawful only when:

• The principal has failed to pay the processing fees in accordance with the agreed schedule;
• The processor provides timely notice to the principal regarding the suspension;
• The suspension does not contravene any specific contractual provisions.

- Legal consequences: Where delayed payment persists and materially affects contract performance, the processor may unilaterally terminate the contract and seek compensation for damages under Article 551 of the Civil Code 2015.

5. Does the principal have the right to request an inspection of materials before production?

In a manufacturing processing contract, the quality of raw materials directly determines the quality of the finished products. Therefore, the law permits the principal to inspect materials before they are used in production in order to ensure compliance with the agreed requirements.

• Obligation of the principal to supply materials: Pursuant to Clause 1 Article 544 of the Civil Code 2015, the principal is obligated to supply materials in the agreed quantity, quality, time, and location.
• Right to supervise contract performance: Under Article 545 of the Civil Code 2015, the principal has the right to receive products meeting the agreed quality standards and to claim damages in breaches. To safeguard this right, the principal may inspect materials before production, provided that such inspection is agreed upon in the contract or does not interfere with the processor’s lawful production activities.
• Responsibility of the processor regarding materials: Pursuant to Clause 2 Article 546 of the Civil Code 2015, the processor is obligated to notify the principal and request replacement of materials if the supplied materials fail to meet quality requirements, or to refuse processing where the use of such materials may result in products harmful to society.

V. Why should you seek legal advice from NPLaw regarding manufacturing processing contracts?

Manufacturing processing contracts directly involve production processes, product quality standards, performance schedules, legal liabilities, and various risks arising during the course of cooperation. Receiving timely legal advice from NPLaw can help enterprises:

• Clearly understand the rights and obligations of the parties under a manufacturing processing contract, thereby minimizing risks and disputes during contract performance.
• Accurately determine legal liability where processed products fail to meet quality requirements, violate technical standards, are delivered late, or cause damage to third parties.
• Draft, review, and amend manufacturing processing contracts in compliance with applicable laws, ensuring comprehensive provisions relating to the subject matter of processing, raw materials, production schedules, confidentiality obligations, indemnification responsibilities, and dispute resolution mechanisms.
• Obtain appropriate legal solutions when contractual breaches arise, where performance is suspended or terminated before completion, and receive support in effectively resolving disputes.

The above information is provided for reference purposes only. For detailed advice tailored to your specific circumstances, please contact NPLaw for timely assistance.