Overseas Contract Manufacturing Agreements: Mold Ownership and Liability for Quality Defects
Structuring mold ownership and return, quality standards, notice deadlines, and intellectual property protection
When a company outsources production of its products to an overseas factory, core assets such as molds and drawings remain at the factory. If the agreement does not address who owns the molds and how they are returned, production may stop when the company tries to switch factories. If quality standards and defect notice deadlines are unclear, disputes arise over who bears the resulting losses.
Korea, China, and Vietnam are all Contracting States to the United Nations Convention on Contracts for the International Sale of Goods (CISG), so the Convention may apply to contract manufacturing transactions. This article summarizes the key points to review in the mold, quality, delivery, and intellectual property clauses of a contract manufacturing agreement.
1. Rules Governing Contract Manufacturing Agreements
Korea, China, and Vietnam are all Contracting States to the CISG. Unless the parties exclude its application, the CISG may govern contract manufacturing transactions between a Korean company and a factory in China or Vietnam.
Goods to be manufactured or produced to order are, in principle, treated as a sale (CISG Article 3(1)). However, the transaction is not treated as a sale if the party ordering the goods supplies a substantial part of the materials. If your company provides the raw materials or components, the applicable law must be analyzed separately.
The CISG does not address ownership of property such as molds. The governing law and dispute resolution method should be set out in the agreement, and for disputes with a Chinese factory, the company should also consider whether a judgment or award can be enforced locally.
2. Mold Ownership and Return Conditions
Paying a tooling fee does not automatically make your company the owner of the mold. Depending on whether the fee was the purchase price of the mold, a share of development costs, or an amount spread over the unit price, the factory may claim ownership.
The agreement should state who owns the molds, where they are kept, who is responsible for their custody, and the deadline for delivering them upon a return request. Attaching an ownership plate to each mold and keeping photographs and an inventory list provides evidence in the event of a dispute.
To prepare for a factory holding the molds as leverage over unpaid invoices, the company should also consider a clause separating payment disputes from mold return. The agreement should also address who bears the cost of mold life and maintenance and prohibit the factory from using the molds to produce goods for other customers.
3. Quality Standards and Defect Notice
Approved samples, drawings, tolerances, inspection methods, and acceptance criteria should be fixed in an annex to the agreement. If standards are exchanged only verbally or through messaging apps, the parties will end up disputing whether a product is defective in the first place.
Under the CISG, the buyer must give notice of a defect within a reasonable time after receiving the goods, and in principle loses the right to rely on the defect if it does not give notice within two years from the date the goods were actually handed over (Article 39). It is safer to set separate deadlines for pre-shipment and incoming inspections, along with the method of notice, in the agreement.
The agreement should specify whether the company may demand reproduction, repair, a price reduction, or damages when a defect is confirmed, and who bears the related costs. A clause allowing termination when the defect rate exceeds a certain level should also be considered.
4. Delivery Delays and Production Stoppages
Deliveries are often delayed by long holidays such as the Lunar New Year (Spring Festival) and by raw material supply issues. The official 2027 Spring Festival holiday announced by the Chinese government runs from February 5 to 13, and actual closures at individual factories may be longer.
The agreement should include firm delivery dates, liquidated damages for delay, and a clause allowing termination and recovery of the molds if a delay continues beyond a set period. If the cap on liquidated damages is too low, it will not cover actual losses, so the cap should be negotiated in line with the order volume.
To prepare for a factory unilaterally suspending production or prioritizing other customers, the company should consider a guaranteed minimum production capacity and an advance notice obligation.
| Clause | Key Review Points |
|---|---|
| Applicable law | Whether the CISG applies, governing law and arbitration, enforceability |
| Molds | Ownership marking, custody responsibility, return deadline, separation from payment disputes |
| Quality | Approved samples and tolerances, inspection deadlines, remedies for defects |
| Delivery | Firm delivery dates, liquidated damages for delay, termination and mold recovery |
| Intellectual property | Confidentiality and non-circumvention, local trademark filing |
5. Protection of Drawings, Trademarks, and Other Intellectual Property
Handing drawings and specifications to a factory creates the risk that the same product will be sold through other channels. In addition to confidentiality, the company should prepare an agreement prohibiting use for other purposes and circumvention of the company, in a form that can be enforced locally.
China grants trademark rights to the first applicant, so the company should check whether it has filed a local trademark application before outsourcing production. Without a local trademark, the factory or a third party may register the mark first and block the company's exports.
The agreement should also address ownership of technology and designs developed while improving the product, and the return or destruction of drawings and prototypes after the agreement ends.
6. Implications for Businesses
In a contract manufacturing agreement, molds and drawings are the assets that determine whether a company can switch factories. Documenting the nature of the tooling fee, mold ownership, and return conditions in both the agreement and physical markings on the molds is the starting point for a stable supply chain.
Quality and delivery clauses must specify notice deadlines and remedies in concrete terms for the company to recover actual losses. When placing orders ahead of long holidays, companies should also review the governing law, enforceability, and local trademark protection.
Related Laws and References
UNCITRAL — United Nations Convention on Contracts for the International Sale of Goods (CISG)
Chinese Government — Notice on the 2027 Public Holiday Schedule
