Sales of Goods vs. Processing Contracts in Vietnam. When is a goods sale contract actually a service contract and why does it matter?

Vietnam offers many opportunities for foreign companies in need of manufacturing due to the combination of low labour costs and a large labour force. However, foreign companies concerned with finding a local manufacturer often overlook the seemingly benign step of having a proper contract in place, and in some cases even leave it in the hands of the manufacturer. Both options would be grave missteps on the part of the foreign company—working in an emerging market such as Vietnam often involves dealing with complex and evolving laws, as such expending more energy initially in drafting a contract that meets the needs of the company will save the company from the potential for significant hardship down the road. Furthermore, taking the time to draft a proper contract provides the foreign company with two critical things: it will give them familiarity with the Vietnamese legal system and it will allow it to dictate the terms of the contract, as opposed to leaving the drafting in the hands of a local manufacturer who may have equally limited understanding of the laws.

Given that Vietnam has become a nexus for manufactured goods for foreign companies it is important to note the regulatory distinctions in contract drafting that can save a foreign company a lot trouble in the event that they run into a dispute with a domestic manufacturer. Most notably the nature of the goods being purchased distinguishes what sort of contract needs to be established, if a foreign company is simply seeking to buy the goods that a domestic company manufactures in their normal course of business this would be governed by the articles for a sale of property (goods) contract (see Civil Code Law no. 91/2015/QH13 Articles 430-454); however, if the foreign (or domestic) company contracts with a domestic company to manufacture contracts for a specific purpose the contract itself is governed by entirely different set of rules, and is actually a processing contract where the manufacturer is actually paid for the service of making the good, not for the good itself (see Articles 542-553). This can come as a surprise to many foreign companies because in the United States for example both would be considered Sales of Goods contracts, and the latter would simply have enhanced protections as a custom-made good.

The distinction is important because having a properly drafted contract will provide the supplier protection in the event that the manufacturer/processor breaches the contract. Whereas if the supplier has a standard form of sales of goods contract when it should be a processing contract, the contract itself will be unenforceable because processing contracts must be in writing, i.e. the unenforceable written sales of goods will not be implied as an oral processing contract (see Commercial Law no. 36/2005/QH11 Article 179). The nature of a processing contract involves the exchange of raw materials, supplies, equipment, and/or funds to acquire such things before the final good is even made, and while it is the final good that is the desired output for the supplier, these materials, supplies, and equipment still have value, and without the proper contract in place can be left at the mercy of the manufacturer. Article 553 of the Civil Code requires that leftover materials be returned to the supplier, and as such the processing contract will contain provisions for tracking the usage of raw materials, while a standard sales of goods contract will not, and under such a contract quality control employees would only concern themselves with the finished goods and not the materials going into production. By having a processing contract the usage of raw materials will presumably be accurately tracked, and allow a supplier to conduct their business more efficiently, as they will be able to forecast the amount of materials required to build the product, whilst preventing careless turnover of these materials to the manufacturer seeking to make an additional profit on a secondary sale. Finally having a processing contract will not allow a disgruntled manufacturer to hold materials, supplies, or equipment as ransom in exchange for payment if they fail to provide the service they are contracted to perform because, as mentioned above, under the law a manufacturer is expressly prohibited from doing so.

Additionally the Civil Code section detailing processing contracts still allows the flexibility for a supplier to reject the goods if they are not made to the quality desired, as that would be indicative of poorly performed service. On that note the supplier dictates the desired quality, as opposed to in a sales of goods contract where the seller (or the manufacturer in a processing context) provides the assurances as to the value of the product, and the onus is on the buyer to find a defect. Thus without a proper processing contract in place, a supplier/buyer foregoes to some extent his right to reject the goods, as the standard for evaluation would shift from a subjective perspective (i.e. what the supplier desires) to an objective perspective (i.e. is the product worth what the seller says it is). So rather paradoxically a processing contract—a contract for services—will actually provide a buyer with more control over what the finished goods are. Furthermore because a processing relationship is concerned more so with the manufacturing than the goods themselves the code makes provisions for having quality control employees on behalf of the supplier on site to oversee the production process, which is an additional protection that is not found in the articles describing contracts for sales of goods.

Ultimately the two contracts are very similar in appearance as their both concerned with end products, but for supplier/buyers who are seeking out goods made-to-order in Vietnam having the proper processing contract in place can save a supplier/buyer a lot of hassle in the event that they run into a dispute with their manufacturer.

Authored by Russell Whitman and Giles Cooper.  For more information please contact GTCooper@duanemorris.com or any of the lawyers in our attorney listing for Vietnam.