The Pharmaceutical Vestnik (Farmatsevtichesky Vestnik) journal has published commentary by Roman Shabrov, Attorney and Partner at BRACE Law Firm, examining critical legal considerations when drafting cross-border supply contracts with Chinese manufacturers.

As Roman highlighted, manufacturing and delivery delays, post-initial shipment quality degradation, high defect rates, and non-compliance with product labeling requirements rank among the most pervasive breaches of international supply contracts encountered by Russian life sciences companies operating in China.

Before executing any agreement, corporate counsel must conduct thorough due diligence on the selected manufacturer. This assessment should encompass not only a legal background check but also a physical, on-site audit of the manufacturing facility.

In the Chinese market, foreign buyers typically engage with three categories of counterparties: manufacturers, trading companies, and small-scale wholesale vendors. International businesses generally prefer dealing directly with manufacturers, as this structure enables direct operational control and the enforcement of bespoke quality standards. Conversely, trading companies and retailers routinely impose higher price margins and supply standardized, off-the-shelf products only.

The underlying contract must stipulate product quality requirements with maximal specificity, incorporating explicit references to technical documentation and compliance standards. Russian pharmaceutical companies frequently face execution issues when obligations are left unspecified, as manufacturers may omit or improperly perform uncodified terms.

Under PRC law, a seller must deliver goods conforming to the quality standards contractually agreed upon by the parties. If the delivered merchandise fails to satisfy these criteria, the buyer is entitled to hold the seller liable for breach of contract in accordance with the stipulated terms.

Paragraph 8 of the Protocol on General Conditions of Delivery of Goods between the USSR and the People's Republic of China requires the parties to define quality provisions within the contract body. It further dictates that technical and qualitative characteristics must be determined by cross-referencing national standards, international organizational metrics, or other regulatory technical documentation. Additionally, parties may establish quality baselines by referencing a mutually approved product sample or predefined specifications.

Given that both PRC and Russian statutory frameworks lack specific provisions governing contract manufacturing arrangements, the parties must meticulously delineate these frameworks within the contract. Currently, three primary contract manufacturing models dominate the Chinese enforcement landscape:

1) “OEM” (“original equipment manufacturer”): manufacturing products under the customer’s trademark using the manufacturer’s proprietary technology;

2) “ODM” (“original design manufacturer”): manufacturing based on the customer’s samples, specifications, and/or technical blueprints. This highly capital-intensive format is favored by large enterprises; while it demands significant financial and time investments for product development and assembly line configuration, it ensures an elevated degree of production control;

3) “OBM” (“original brand manufacturing”): the manufacturer owns the brand and bears comprehensive responsibility for product design, R&D, manufacturing, and commercialization, without limiting the outsourcing of secondary production engineering operations.

When structuring cross-border agreements, establishing the governing law and dispute resolution forum remains a paramount consideration. In addition to domestic statutory frameworks, cross-border commerce between the Russian Federation and the PRC is subject to the Protocol on General Conditions of Delivery of Goods and the United Nations Convention on Contracts for the International Sale of Goods of April 11, 1980 (the CISG / Vienna Convention). Contracting parties may explicitly exclude the application of both the CISG and the Protocol. Notably, jurisprudence from the International Commercial Arbitration Court (ICAC) at the Chamber of Commerce and Industry of the Russian Federation indicates that the CISG governs the disputed relationship unless explicitly disclaimed. Furthermore, certain ICAC rulings have affirmed the precedence of the Protocol over the CISG in specific contexts.

In the absence of a valid arbitration clause, Paragraph 52 of the Protocol prescribes the following default jurisdictional rules:

• if the defendant is a Russian enterprise or organization, the dispute shall be adjudicated by the Arbitration Court at the Chamber of Commerce and Industry (i.e., the ICAC at the RF CCI, as its legal successor);
• if the defendant is a foreign trade enterprise or organization of the PRC, the dispute shall be resolved by the China International Economic and Trade Arbitration Commission (CIETAC) in Beijing, in accordance with its procedural rules.

However, these Protocol provisions are non-mandatory and do not restrict the freedom of the parties to mutually designate alternative international commercial arbitration forums.

Opting for the jurisdiction of state commercial (arbitrazh) courts of the Russian Federation can create severe enforcement challenges within Chinese territory. Conversely, selecting PRC state courts introduces complexities, as Chinese judges face substantial difficulties when interpreting and applying Russian law. Consequently, if the parties opt for dispute resolution within China, they must proactively formulate a robust litigation strategy to address potential contractual defaults by the manufacturer.

Concurrently, corporate counsel must recognize that initiating litigation or threatening legal action during negotiations is perceived by Chinese counterparties as highly adversarial—effectively a declaration of hostilities. Legal proceedings should be initiated exclusively as a matter of last resort when alternative dispute resolution (ADR) mechanisms are entirely exhausted. Commercial disputes within this jurisdiction are primarily resolved through strategic negotiations and structured mediation. Pre-trial settlement forms the cornerstone of the Chinese judicial architecture; therefore, parties can and should deploy pre-trial settlement mechanisms at every institutional and judicial level.

Finally, securing an optimal payment structure is critical. In light of the stringent sanctions compliance protocols enforced by major Chinese banking institutions, cross-border agreements must incorporate both primary and alternative clearing mechanisms, including the utilization of verified intermediaries.

When defining payment terms, the parties must scrutinize payment schedules, installment sizes, and the inclusion or exclusion of a unilateral price adjustment clause. To maintain critical commercial leverage over the Chinese manufacturer, we strongly discourage agreeing to 100% advance payment structures for scheduled shipments.

To mitigate regulatory and operational risks, we recommend that international companies implement the following safeguards:

1) Conducting comprehensive legal due diligence on the manufacturer and executing on-site factory audits prior to contract signing;

2) Specifying the technical characteristics of the supplied goods within the main agreement or a dedicated Statement of Work (SOW), or, more reliably, executing a separate Quality Agreement as an integral appendix;

3) Producing product samples to serve as the binding baseline for verifying subsequent batch quality compliance;

4) Requiring the seller to verify compliance with national and EAEU regulatory frameworks by obtaining all necessary product certificates, noting that some manufacturers may resist taking on certification burdens;

5) Incorporating an express contractual right to conduct independent quality expertise, alongside clear provisions governing product returns, cost indemnification, and secondary expenses (including logistics and customs clearance costs);

6) Implementing pre-shipment quality control inspections, either independently or via specialized third-party inspection firms, or establishing a joint quality oversight mechanism covering all manufacturing stages;

7) Designating a precise, mutually agreeable dispute resolution forum within the body of the contract;

8) Establishing clear, multi-tiered payment terms and currency settlement routes;

9) Pursuing pre-trial alternative dispute resolution mechanisms, specifically structured negotiation and mediation, prior to initiating formal litigation.

The full text of the article and commentary is available on the publisher’s website: https://pharmvestnik.ru/articles/Kitaiskaya-gramota-Chto-predusmotret-v-kontrakte-s-proizvoditelem-iz-KNR-2.html, and can also be accessed in the appendix here.