China trademark Lawyer
Don’t be late with your China IP renewals

Every so often one of our China IP lawyers will get an email from a foreign company (usually a North American or European or Australian company) whose China trademark registration (usually) or China design patent registration (sometimes) did not go as expected. And every so often, one of our China IP lawyers will discover that a trademark our new client paid to have filed in China was never filed. Not to mention the times foreign companies pay to have their trademarks registered in China, only to later learn that the whole thing was a complete scam. In an article entitled Is Your China Lawyer Real, I discussed fake China law firms:

We have many times represented companies that paid money to a Chinese “law firm” for registering a trademark in China or drafting a    manufacturing agreement or forming a WFOE, only to learn that they had instead paid money somebody who had set up a temporary website with the sole intention of bilking the unwary. I have never heard of a real Chinese lawyer doing this. The trick is knowing who is a real lawyer and who is not.

I then discussed the sort of due diligence you should undertake before hiring a China lawyer, or any other lawyer, for that matter.

As more foreign companies are getting to the point where they need to renew/extend their China IP, our China IP lawyers are getting an increasing number of emails involving trademarks or design patents that were filed properly ten or so years ago, but the attorneys/law firms that handled the original filing are no longer around to mind the store. The below email (with a few slight modifications to preclude any identification) is fairly typical of this new breed of problems with which we are having to deal:

Here is one that you may not have come across.

In 2006 I took out a trademark for a product we make through a law firm in Shanghai. It was a small office off Changle Lu and they were very helpful and seemed to know what they were doing. Today I had reason to check the validity of the trademark and noticed that it had expired. I don’t remember anyone talking about this and so rang the attorney’s office to check on what we should do about this. It turns out that the person I was dealing with left in 2009 and the owner of the firm died soon after. They were supposed to send out a renewal notice, which I am sure they did not. They say they did, but our address and phone numbers are unchanged and nobody has died either. It is just another one of those China things. I understand that I now have to go through a special approval process because I did not apply for renewal within six months before its expiration.

I was very new to China when I did this and was quite naive about this sort of thing, believing that I was in the hands of professionals before I realised that they are very thin on the ground here. Also we had yet to set up our systems in the office and so we did not have any automatic reminders popping up, so I accept that it is partly my own fault (but in 2006 I had much more pressing things to occupy my mind). Can you help us on this new go-round?

Fortunately, this particular company came to us in plenty of time to fairly easily remedy this minor misstep. But we are aware of other foreign companies that have lost or compromised their China IP protections by having missed IP filing deadlines.

Bottom Line: Choose your China IP counsel wisely and consider maintaining your own IP calendaring system as well. And don’t be late.

China manufacturing agreementsWhen we first began drafting manufacturing agreements for clients outsourcing their manufacturing to China, one of our China lawyers would send the client a six page questionaire to tease out the client’s China manufacturing plans. But no matter how hard we tried, there were almost always important questions our client either did not understand or unable to answer. We quickly realized that dumping six pages of questions on our clients was too much, especially since a particular answer to one question might mean a few other questions had become irrelevant.

We met with legal tech people to see about using technology to simplifying the process but we soon determined that would hardly help at all. These are not the sort of contracts that can be automated. Rather these contracts require the China attorney working on the manufacturing agreement to be in constant “live contact” with the client to help the client determine what makes sense for its industry, its company, and its product. So we instead switched to a system where we ask questions in “waves.” When we get answers to the first wave, we review those answers and ask a second wave and we keep going until we have all the information we need to start drafting the contract. We then draft the contract in English for our client to review and then we draft it in Chinese as the official version, with an English language version as a translation for our client. See Get Your China Contracts Written In Chinese, Not Translated and How To Draft A Contract For China. This has also become our standard operating procedure for our China NNN Agreements and our China Product Development Agreements as well.

I thought of all this today while reviewing a client’s email response to the first wave of questions for its China manufacturing agreement. The answers made so much sense that drafting wave two of questions will be a breeze. I am going to share this first wave of questions because they should make for a good starting point for Western companies seeking to determine how to have their products manufactured in China. Note that even our first wave of questions is tailored to the specific client so a few of the below questions are not relevant to every industry, company or product.

This is ____________ from Harris Bricken. I will be drafting your manufacturing agreement for China. To kick off this project, I have some preliminary questions. I will have other more specific questions based on your answers.

1. I note from your website that you have an extensive product line. Which specific products from that line do you want this manufacturing agreement to cover?

2. Do you have a specific set of factories in China with which you are already working? Or do you want this manufacturing agreement to be used for new factories? Or both?

3. In what PRC region(s) are your factories located?

4. When you work with factories, do you set a specific product amount on an annual or other fixed basis? Or do you work on a per purchase order basis, with no fixed annual order amounts?

5. What is your pricing arrangement with the factories? Is there a set price fixed for a specific period? If there is a set price, how is that price level enforced?

6. What are your payment terms? Do you pay an initial deposit? When is the final payment made?

7. How do you provide for submission and maintenance of samples? I know that in your industry, products are normally made in reference to a physical sample, rather than to a drawing or CAD diagram or similar. What system do you use?

8. What is your system for inspection and quality control? Do you inspect during production? Prior to shipment? After you receive the products in the United States and in Europe? After delivery to your customer? What is the specific system for dealing with defective/non-conforming product discovered at any of these four points in the system?

9. Do you have a system for dealing with inspection and related specific safety standards in place in the U.S. and in Europe? For example, flammable fabrics, non-lead paints, small pieces on toys and related. If so, what is the division of responsibility between your company and the Chinese factory?

10. Do you have a system for dealing with the quantity of orders made over time? Since many of your products are seasonal in demand, do you have some form of scheduling system to ensure that the factory will have capacity to deliver your orders during peak seasons?

11. What is your procedure for packaging and shipping? What are the shipping terms? How is pricing linked to shipping terms? To where is the product shipped? To your warehouses in the U.S. and in Europe, or directly to your customers?

12. I understand that you distribute some of your products for sale in China. Have you considered how the China side of your operations might impact this agreement, if at all? If we can ignore the China entity/sales issue at this time, that is fine, but we should discuss this.

13. I understand that you have been having products manufactured in China for more than a decade. What specific problems have you encountered that you want your new manufacturing agreements to resolve?

If you would like to discuss any of these matters over the phone or by Skype, and I would be pleased to speak with you.

For more on what goes into China manufacturing agreements I urge you to check out Having Your Product Made In China: The Basics on Protecting It and You and the links within that post.

China lawyerIn my first post, I discussed China’s efforts to build stronger economic ties with Mexico – and why Mexico should be clear-eyed about China’s motives. In my second post, I examined the current economic relationship between Mexico and China. In this post, I will discuss why the economic relationship between China and Mexico has made so little progress.

At first blush, it is difficult to understand the disjunction between what has been said and what has actually been done. The two countries have signed an Integral Strategic Partnership, and China has explicitly offered its assistance should the Trump administration turn its back on Mexico. The Chinese ambassador to Mexico has claimed the two countries’ relationship is “better than ever,” but trade and investment levels are pitifully low, and for a variety of reasons those numbers are unlikely to change.

One huge reason Mexico’s relationship with China is unlikely to change is the existence – and proximity – of the United States. The United States has a huge (and growing) Hispanic population eager to consume a vast array of Mexican exports, whereas Chinese consumers are only interested in a few select Mexican products. Just look at the numbers. Mexico’s annual exports are worth $400 billion, and $291 billion of that goes to the United States. Only $8 billion goes to China. The American government has not exactly welcomed China’s attempts to establish closer ties with Mexico, and there are strong rumors Washington played a big role behind the scenes in the cancellation of the Mexico City-Queretaro rail and the Dragon Mart Cancun projects. Even if the Mexican and U.S. governments are not currently best of friends, our two countries will always be neighbors.

It is also true that Mexico and China have little economic synergy. China is Mexico’s direct competitor in the United States and for many of the same products. According to a study produced by UNAM, the University of California, Berkeley and the University of Miami, from 2000-2011 both the U.S. and Mexico suffered substantial losses in their respective export markets in the NAFTA region. The study identified 52 sectors in Mexico in which the U.S. was losing market share and China was gaining, creating the inference that Mexico was making efficiency gains and had become more competitive in U.S. markets. However, the study found that Mexico was also losing market share in the U.S. in those same 52 sectors. In other words, China was outcompeting both countries — in part because of its advantage in manpower and its government subsidies.

The disconnects are on both sides. Mexico has failed to attract meaningful investment from China and instead focuses on Chinese tourism. Chinese companies have made little effort to do anything in Mexico beyond selling products to Mexican consumers. Mexico has failed to take advantage of China as an export market and has fallen back on sending China non-value added items such as tequila, pork, and fruit. The Chinese government does not make it easy for Mexican companies to enter the Chinese market. And China’s economic model depends on being able to run huge trade surpluses. Combine with this the devaluation of the peso and the rise in gas prices, and the result has been inflation that makes Mexican exports less attractive overseas. According to the Inter-American Development Bank, Mexico’s exports fell 4% in 2016.

Part of the problem has nothing to do with China and everything to do with Mexico. 99.8% of all businesses in Mexico are small and medium-sized enterprises (SMEs) and the vast majority of them are unsophisticated companies, with little interest in or knowledge of how to operate on an international scale. When these companies do seek to engage with China, some (or all) of the following problems arise:

  • lack of due diligence about the Chinese market and possible business partners
  • poorly implemented corporate governance structures
  • failure to appreciate the paramount importance of IP protection, evidenced most often by discovering too late that a third party in China has registered “their” trademark
  • lack of cultural and language proficiency on the part of Mexican staff, leading to an inability to deal with Chinese authorities
  • inappropriate delegation of all responsibility for Chinese operations to poorly supervised Chinese staff
  • lack of transactional oversight due to (relatively) low dollar values

And though more and more Mexican nationals are going to China for education and training, few Mexican companies know what to do with them upon their return to Mexico.

Perhaps the biggest problem Mexican companies face in China – and frankly, the same problem bedevils Chinese companies going abroad – is that they think they can operate overseas the same way they do at home. I still remember the first matter I handled with my company: a Mexican enterprise was operating in China, but had no idea about their legal status in China or whether they were operating legally. Everything from company formation to payroll had been delegated to their Chinese accountant, and as a result they had hired staff without any written contracts, they were not contributing to social insurance or housing funds, and they were paying everyone in cash. It was just a matter of time before they were found out and had the book thrown at them.

Finally, a nontrivial number of Mexicans (and some Chinese) consultants want Sino-Mexican relations to remain in this relatively primitive state, because this will allow these consultants to continue as “indispensable” founts of wisdom and knowledge in an uncertain world.

The one bright spot is the .02% of Mexican enterprises which are not SMEs. These enterprises are the huge multinational corporations known as multilatinas, and they are already operating in China as part of their global strategy. Some of them are already selling more goods in China than in the U.S., and to a one they plan to focus even more on the Middle Kingdom in the years to come. They would not be doing this if they weren’t already doing well in China. As global companies they consider themselves able to compete on the global stage, and you know what? They’re right.

In my concluding post, I’ll look to the future and specifically on how to improve the China-Mexico business relationship.

The above post is by Adrián Cisneros Aguilar. Adrian is the founder/CEO of Chevaya (驰亚), an Asia-Pacific internationalisation services company. Adrián has a Doctor of Laws from Shanghai Jiao Tong University and an LL.M. in International and Chinese Law from Wuhan University.

China AttorneysBecause of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a super fast general answer and, when it is easy to do so, a link or two to a blog post that may provide some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

I came across your blog while researching employment contracts in China. Is there a standard amount of notice employees are legally required to give their employer when breaking a contract in China, or does it depend on the company itself? Also if I am going to give less time than is legally required, is it standard to pay for those days to exit the contract professionally? And is it standard to give the full amount of time or even more?

You are asking essentially two questions. One is a social/employment/morale/reputational one and the other is a legal one. We don’t know the answer to the question of how much time you should give in your particular industry or locale (especially since we do not even know your industry or your locale), so we would urge you to ask around so as not to harm your future employment chances in China (and if yours is a small industry, perhaps worldwide as well). As for the legal side, it should be whatever the employment contract says, so long as the applicable national, provincial, or local laws do not override that, which any one or more of these very well might. I urge you to read our post, China Employment Law: Local and Not So Simple. Unlike in most countries, it is not uncommon for China employers to sue an employee who fails to provide the legally required notice for leaving, so it is generally a good idea either to give the full notice that is legally required, or reach a written agreement with your employer letting you off the hook (probably by your paying money) for not doing so.

 

China employment lawyerChina’s labor laws require employers provide their employees paid vacation days based on their total years of service. Employers are legally obligated to ensure their employees take their vacation days and to the extent the employer fails to do so, it must pay the employee an additional 200% of her normal wages for each unused vacation day.

The law also requires China employers pay their employees for unused vacation days at the time of termination. One question our China employment lawyers are often asked is whether an employer has the same payment obligation when it unilaterally terminates an employee for employee breach. The governing law is silent on this. But since it says that at the time of termination, an employer must pay employee compensation for unused vacation days, a strict interpretation would dictate such a payment must be made. As is typical of almost everything China employment law related, the real life answer depends on where the employer is located and even at which court the labor dispute will be adjudicated. For example, the general view of the Shanghai courts is that an employee terminated for her own fault is not entitled to payment for unused vacation days, because she is at fault for being terminated before she could use all of her vacation days.

This though gets complicated when the unused vacation days are spread among several years. For example, suppose an employee terminated in 2017 due to employee breach did not use any vacation days in 2017 prior to her termination. Assuming the employer’s unilateral termination decision was held to be lawful, the employer will probably not be required to pay the employee for unused vacation days in that year. But suppose that same employee was never paid for unused vacation days in 2016 either. In that case, the employer very well may be required to pay for unused vacation days — assuming the employee did not voluntarily relinquish her vacation time via a clear writing and the statue of limitations has not otherwise run out against the employee.

Employees usually do not pursue labor arbitration just to try to collect money for a few unused vacation days. These claims typically show up as part of a claim challenging the lawfulness of the employee termination. So this is yet another reason why unilateral termination can be so problematic. Employers that unilaterally terminate their China employees often find themselves caught up not just in one lawsuit but in several proceedings—labor arbitration, trial, appeal, and sometimes a retrial and in most of those proceedings, it has to defend itself against not just its termination decision but also against multiple other ancillary claims. “Mutual” terminations with a clear written settlement agreement avoid the employer having to jump (stumble) through so many hoops.

Also, like most aspects of China employment law, vacation time is not an area where it makes sense getting creative. For example, don’t just assume that a provision in your rules and regulations stating that your employees forfeit their unused statutory vacation time by not taking that time. Think twice before you ask your China employees to give up something to which they are legally entitled. If you are unable to secure a separate written agreement (in Chinese) from your employee saying she voluntarily chooses not to take her vacation time (who would, really?), you must pay her for those days or find a way to let her take the paid time off.

Last but not certainly least, we also are sometimes asked whether employees under the flexible working hours system are entitled to statutory vacation time just like employees under the standard working hours system. The answer to that is a resounding yes.

 

 

My first post in this threeChina manufacturing lawyers part series focused on a post entitled The 7 Major Risks You Run With Your China Manufacturers, by China manufacturing expert Renaud Anjouran. In that post, Renaud outlined the business risks foreign companies face when having Chinese factories manufacture their products. I noted how Renaud’s list nicely accords with what our China lawyers tell our clients who retain my law firm to draft their Chinese manufacturing contracts. See China Manufacturing Agreements: Binding Contract or Contract Terms. I noted how our manufacturing clients usually want to focus on a) intellectual property protection/prevention of counterfeiting, ownership of molds and tooling and after sales warranty service. In other words, the sorts of things legal agreements are really good at resolving. But oftentimes, core business issues like price, quantity, delivery date, quality and resolution of quality issues, subcontracting and shipping are of at least equal importance.

My second post focused on the first four items on Renaud’s China product outsourcing list. In this, my last post in this three-part series on China manufacturing, I focus on the last three items from Renaud’s list.

Risk Five: Subcontracting. Subcontracting of production presents a number of risks often not clearly understood by foreign buyers. Renaud identifies the first and most common risk. The foreign buyer goes to substantial effort to verify that the Chinese factory it has chosen is capable of meeting its quality standards. If the factory then subcontracts the foreign buyer’s product manufacturing to another factory, all of the buyer’s verification work becomes meaningless. This then leads to other issues: How will inspections take place? How will quality control standards be enforced? How will worker safety or worker age rules be enforced? How will anti-bribery and related rules be enforced? Working to the next level, manufacturing by a third party where there is no contractual relationship means that confidential information agreements are automatically breached, and this is a primary way intellectual property gets lost in China. Finally, molds and tooling are often moved to the subcontractor, resulting in loss of control and the inability to retrieve these items when required.

There are three reasons Chinese factories typically subcontract. First, the “factory” is a front for a trading company that actually does no actual manufacturing on its own. This type of trading company will subcontract all of the manufacturing and will limit its involvement to supervising (usually very poorly) the manufacturing process. Second, the factory may be capable of doing the basic manufacturing process, but it requires subcontracting assistance on key elements of the production process. For example, it is normal for Chinese factories to subcontract mold making and electroplating of key components. Finally, the factory may decide that the foreign buyer’s purchases are too small to justify the effort of setting up production and it will subcontract to a factory with the time and the interest. Such a factory is almost guaranteed to be of lower quality, leading to the problems Renaud describes in his post.

Since subcontracting is always an issue when manufacturing in China, it is necessary to confront the issue directly in a formal agreement. The standard approach is to provide that subcontracting is prohibited without notice to and consent by the foreign buyer. The foreign buyer should condition its consent on inspecting the subcontractor and getting the subcontractor to execute a separate manufacturing contract with the same key terms as the foreign buyer has with its original manufacturer.

Though this approach is best, many Chinese factories insist on an absolute right to subcontract. In that situation, if the foreign buyer agrees, then the normal contract provision is to require (a) the Chinese factory at least identify its subcontractor(s) (b) the subcontractor grant the foreign buyer access to its premises for inspection and c) the Chinese factory agree to be directly liable for any violations committed by the subcontractor. Some Chinese factories will not agree to these conditions. When that happens, our China lawyers recommend the foreign buyer refuse to purchase its products from that factory.

Renaud identifies a more difficult problem: undisclosed subcontracting. This situation is unfortunately quite common. It arises most often during the busy season when a factory simply cannot keep up with the orders it has accepted. The best way to prevent this from taking place, the foreign buyer must regularly inspect the factory operations to ensure that the factory is really doing the work on the premises. Since the high season is the most likely time subcontracting will occur, this is the time when appropriate, unannounced inspections should occur. It is also crucial to enter into a formal agreement that prohibits undisclosed subcontracting as described above.

Way back in 2009, in The Six (Not Five) Keys To China Quality, we wrote about the tremendous value of putting a no-subcontracting provision in your China manufacturing agreements:

We typically put a provision in our OEM agreements (which we nearly always do in Chinese for better enforcement in China against the manufacturer) mandating that the Chinese manufacturer cannot subcontract out the manufacturing. We have been doing this for years and, as far as we know, no manufacturer has ever violated this provision. I know many of you are dubious of this record, but hear me out. Let’s say the Chinese manufacturer has 30 customers for whom it manufacturers product. Let’s say only four of those customers have a no subcontracting provision (my guess is this number is more like to be two, but for the sake of argument, let’s go with four here). The China OEM manufacturer gets really busy and has to subcontract out some of its manufacturing. It can subcontract out the product manufacturing of any of its 30 customers, so why wouldn’t it choose to subcontract out the product for the 26 customers who have no contract provision prohibiting subcontracting? I call this the bike lock theory of Chinese law because the no-subcontract provision operates like a good bike lock. The thief can still steal your bike, but why would he when there are so many easier targets out there?

In our experience, these no-subcontracting provisions work shockingly well.

Risk Six: Failure to Deal with Defective Product. The problem of defective products raises several issues. First, it is critical to identify a factory that will attain and maintain a reasonable defect rate. If the defect rate during production is over an “epidemic percentage” level, it is almost certain success will not be achieved. As Renaud illustrates in his post, the defects in Chinese factories are often at the cosmetic level. The base product is acceptable, but the finish is defective or scratched; fingerprints show up on glass in an enclosed case; greasy footprints are found on well sewn, elegant handbags.

There are two issues relating to dealing with such defects. The first is how to locate the defect. It is best to locate the defect during the production process. Second best is to locate the defect before shipping. Third best is to locate the defect after your receipt of the product. The worst case is to learn of the defect after delivery to the down stream customer.

As Renaud notes, once defects are found, the parties must have in place a formal plan that clearly deals with what will be done with the defective product. It is critical not to allow the defective product to enter into the retail market. Many Chinese factories will sell defective product “out the back door.” When this product gets into the market, the damage to your reputation can be substantial.

But what should be done with defective product? We usually provide that the defective product must be destroyed. However, this is not always the best alternative. In some cases, the defective product can be repaired or otherwise reworked. This is a common approach for complex and expensive cast metal parts for large equipment. In other cases, the defective product can be disassembled so that valuable components, such as precious metals, can be recovered.

Once you resolve how to handle defective products you receive from your China factory, your next issue is how to get reimbursed for the defects. The Chinese side will usually propose that the value of the defective product be applied as a credit against your future purchases. This is a bad system because the foreign buyer can only obtain credit if it makes another purchase. This forces the buyer into a relationship with a factory that makes defective product. Even worse, the amount paid to the factory is going down for each new purchase, which means the factory has even less incentive to do a good job.

The practical solution is for you to inspect your product before making any payments for its manufacture and reducing the invoice price to account for any short delivery resulting from removal of defective product from any given shipment. If the defect level reaches an epidemic failure rate (this rate must be determined on a product by product basis), your manufacturing contract should provide for you to be able to impose additional penalties. Foreign buyers that delay dealing with quality issues until after they have made full payment for their product are virtually never able to successfully resolve their China product defect issues.

The above discussion shows that a detailed, formal system for dealing with quality control and handling of defects is required and the only way to do this is with a formal, written manufacturing agreement. The common one line statement that the Chinese factory will warrant the quality of its products will never work. Manufacturing in China will ALWAYS result in defects. A workable plan for dealing with those defects is therefore not optional. It is required.

Renaud’s post raises an even more important issue. In some cases, the defect level from the factory will be high and will remain high. In that situation, where a defect rate is over 20%, it is normally impossible to develop a workable solution with the factory. The solution here is to monitor the process from the very beginning. In China, factories do not do better work over time. Their performance almost always only gets worse over time. As soon as an excessive defect rate is identified, you should take immediate action. Usually that immediate action means cutting your losses and moving to a new factory. A good manufacturing agreement will make this transition as easy as possible.

Risk 7. Logistics Cost Increases Due to Factory Error. As Renaud notes, you need to beware of increased shipping costs due to your factory making an error in the size of container required to ship your product. This issue arises from a common mistake make by foreign buyers. Inexperienced foreign buyers often do not understand that in international transactions, “logistics” is an integral factor for success. Shipping costs, shipping timing, method of shipment (air/ground/ocean), port of delivery and a host of other factors can have substantially impact the marketability/pricing of your product.

This then leads to the standard mistake. The foreign buyer looks for the lowest China Price. So the China manufacturer provides a product price that does not include the shipping cost: free carrier or the (erroneous) FOB price. Under these terms, it is the foreign buyer’s responsibility to make arrangements for shipping. The illusory concept is that the foreign buyer will then negotiate the lowest shipping rate, making for an even higher profit.

In fact, however, foreign buyers are normally unable to effectively manage shipping in China. So even though they specify free carrier terms, they in fact end up needing to rely on their Chinese factory to make all the arrangements for shipping. But under this scenario, the foreign buyer has taken on all liability for mistakes and yet it has no effective control to prevent those mistakes. This then is a perfect setting for the kind of disaster that Renaud describes.

From a legal perspective, resolution of this problem is simple. The foreign buyer’s contract with its China factory should reverse impose all of the responsibility and liability for shipping on the China factory. This is done with a manufacturing contract that provides for the product price to include shipping fees. The standard CIF (cost insurance freight) shipping term will achieve this goal. Use of CIF terms does not mean that your China factory will not make mistakes, but it does mean that your factory (not you) will be liable for those mistakes. Your China manufacturing agreement should also include a provision that requires your factory ship by air freight if delivery of your product will be delayed beyond a certain number of days. The only way to ensure that your China factory treats your key business issues as important is for your manufacturing agreement to impose an immediate penalty on your factory that does not require a cross border lawsuit to enforce.

 

China employment lawyers
Do not flick off your China employees!

The old saw, “hire slow fire fast” does not work for China. This is because China employee terminations require far more careful legal handling than in the United States. When it comes to employee terminations, China is still very much a Communist country. Think France not the United States. I estimate botched terminations cost foreign companies on average around five times as much as a well-handled termination that includes severance, and yet our China employment lawyers spend more time trying to fix badly done terminations than providing legal consulting on how to achieve one correctly.

This is largely because in disputes arising from an employee termination, the employer bears the burden of proving its termination was both handled properly and justified. This means that for an employer to prevail in a termination dispute, it must have the evidence/records to support the termination.

A recent employee-employer case out of Shenzhen nicely highlights the importance of the employer have good evidentiary support, and what can happen to an employer lacking that support. The facts of this case are not terribly complicated and I have simplified it even more for this post. A Shenzhen employer issued a written notice to an employee immediately terminating the employment relationship. At trial, the parties did not dispute the termination date (even though this issue is often contested) or that the employee actually received the termination notice (even though this is often contested by the employee). The termination notice essentially said nothing more than “we are unilaterally terminating your contract.” The employer contended that it had fired the employee for a series of breaches of the employer rules and regulations and alleged it had orally explained the reasons for the termination to the employee when it delivered the employee’s termination notice.

The Shenzhen intermediary court basically said that the employer had failed to specify the grounds for termination when it served the employee with the termination notice because oral communications of those grounds do not count. Since the employer never gave its terminated employee the grounds for termination, the court deemed the termination to have been unlawful and it awarded the employee the full amount of statutory severance, doubled.

Complain all you like about this court decision, but recognize that if you should find yourself in the same situation as the Chinese employer who lost this lawsuit, you too will probably lose 999 times out of a 1000. This court handled everything “by the book,” which is 100% par for the course in China employer-employee disputes. The employer lost because it got lazy and failed to do something the law required it to do and because it had no good evidence that it had done it. Had this employer merely provided its employee with a written explanation for the termination and made the employee sign for having received that written explanation (it does not hurt to videotape the providing of notice), it no doubt would have prevailed. In other words, all the employer needed to have done was to have strictly complied with the law.

All the employer needed to have done was to have fired slow, by first determining all necessary steps to a proper termination under all applicable China and local laws, and then done all that it needed to do to act accordingly.

WeChat and China WFOEAnyone who pays attention to China knows WeChat is the biggest name in Chinese social media. But the extent of WeChat’s dominance, and the way it has integrated itself into nearly every aspect of daily life in China, has significant implications for foreign companies doing business in China.

More than 95% of Internet users in China access the Internet via mobile devices at least part of the time. And of those mobile users, about 80% use WeChat. That is a stunning number, especially when you consider that WeChat is not just for sending messages and sharing news, pictures, and video; it also offers online shopping, mobile payments for everything from groceries to Lunar New Year “red envelopes” (gifts of cash), and Uber-like vehicle for hire services. More than 300,000 retail stores have already integrated WeChat Payment into their point-of-sale systems.

Given the ubiquity of WeChat, numerous companies have opened up official WeChat accounts and regularly use them to share information about products and promotions. Companies do exactly the same thing on Facebook in other countries, but because Chinese consumers can do so much more on WeChat, dispensing information via an official WeChat account is just the bare minimum. Chinese consumers have come to expect more.

A recent story about Starbucks becoming the first foreign company to become integrated into WeChat’s Wallet feature highlights the extent to which companies can benefit from WeChat. WeChat’s Wallet feature allows people to purchase Starbucks items and give them to their friends, all within WeChat. Given the love of social gifting in China – it’s how streaming celebrities earn money – I would expect this feature will increase Starbucks sales and it’s a great example of a foreign company adjusting its business strategy to take advantage of the idiosyncratic Chinese economy.

An official WeChat account can be opened by any company. But if you want Chinese consumers to be able to access that account – which is really the main reason to open an official WeChat account – the account must be formed by a legally formed Chinese entity.

That brings us to an old China Law Blog chestnut: do you really need to form a WFOE in China to sell your products? Of course not. There are a number of perfectly good reasons why companies might want to enter the Chinese market without forming a WFOE. But the more WeChat matters, and the more you want to control your company’s message to Chinese consumers, the more important it will be to have a China WFOE (or even a Joint Venture) to take advantage of all WeChat has to offer.

China manufacturing contractMy first post in this three part series focused on a post entitled The 7 Major Risks You Run With Your China Manufacturers, by China manufacturing expert Renaud Anjouran. In that post, Renaud outlined the business risks foreign companies face when having Chinese factories manufacture their products. I noted how Renaud’s list nicely accords with what our China lawyers tell our clients who retain my law frim to draft their Chinese manufacturing contracts. See China Manufacturing Agreements: Binding Contract or Contract Terms. I noted how our manufacturing clients usually want to focus on a) intellectual property protection/prevention of counterfeiting, ownership of molds and tooling and after sales warranty service. In other words, the sorts of things legal agreements are really good at resolving. But oftentimes, core business issues like price, quantity, delivery date, quality and resolution of quality issues, subcontracting and shipping are of at least equal importance.

The source of the problems for Western companies that manufacture in China is the pervasive use of the purchase order approach to purchasing contract manufactured product from China. In China Manufacturing Agreements: Binding Contract or Contract Terms, I wrote how there are two basic ways to structure a China contract manufacturing agreement.

Option One is to enter into a legally binding contract (in Chinese!) that addresses all of the basic manufacturing issues. The agreement on price binds both the Chinese factory and the foreign buyer, and even if costs change, the parties remain obligated to pay and sell the product at the agreed-upon price, no matter which party benefits or loses from the changes. This sort of contract is common in much of the world, but less so in China. China, however, the entire risk tends to be loaded on one side or the other. The same applies to the other key business terms in China manufacturing agreements, such as the terms for payment, quantity, delivery date and quality. Foreign buyers who do not want to be bound or who cannot be bound due to lack of resources will follow Option Two. Under Option Two, the contract terms and conditions are binding on the parties only after a purchase order is presented by the foreign party and then accepted by the Chinese party. It is this lack of a binding agreement that is the primary cause of the seven manufacturing risks Renaud discusses in his post.

The obvious path to contract certainty  is to enter into an Option 1 manufacturing contract that formally commits both parties to the basic business terms for a specific period of time. However, the lure of China for many foreign buyers is that Chinese factories are willing to do small runs on a purchase order basis. The purchase order system is oftentimes THE reason why the foreign company is having its product developed and made in China. For this reason, our primary task as lawyers is to develop contract manufacturing agreements that deal up front with the risks that come from using the purchase order approach. Our job as China attorneys then is to make sure that our foreign buyer clients understand the risks and then to work on mitigating those risks in a practical way.

I explain below and in Part 3 of this series how our China manufacturing lawyers do that with each of the seven risks Renaud identified.

Risk 1: Lack of “Motivation.” The major risk we see stems from the foreign buyer loading the development costs onto the Chinese side with no incentive for the Chinese side to follow through on development. Renaud calls this risk “loss of motivation” and we see this all the time. The foreign side relies on the Chinese factory to do the product development, normally loading the cost on the Chinese factory. After two years, the development is not completed and the market has moved on, leaving the foreign side high and dry with no marketable product. The Chinese side assures the foreign buyer that they are “working on it,” but in fact the product development project is a low priority as compared to their ongoing manufacturing that pays their bills and so they are “working on it” only when times are slack. It is also common for Chinese factories to agree to take on a development project when they do not actually have the capability to do the work. In this situation, the delay results from the Chinese side being pushed up against the limits of what it can actually do.

The best way to address this lack of motivation risk basic method is to enter into a legally binding product development agreement with the Chinese factory that includes the following:

  • Milestones: hard dates for development of prototypes or samples.
  • Allocation of costs. If all costs are loaded on the Chinese side, the chance of success is dramatically reduced.
  • A real incentive for the Chinese side to succeed. This incentive can be payments for the Chinese factory hitting its milestones or it can be a commitment to purchase reasonable (but predetermined) quantities of the developed product at a fair price.

Few foreign buyers follow this approach, with the predictable results described by Renaud.

Risk Two: Quality Failure at the Production Stage. The Chinese side agrees to manufacture the product at the “China Price.” Initial samples are acceptable in terms of quality, but once production starts, the quality is consistently bad. When pressed, the Chinese side says: “We gave you the China Price and you knew that at that price we would never be able to produce a quality product. It is your fault: you have to choose. If you want the China Price, you don’t get assurance of quality, quantity or delivery date. If you want all those items to be acceptable to you, we need a binding contract that covers all four issues in a manner that works for us too. But if you insist on the China Price and you do not provide us with a binding commitment for orders, you will have to accept what we provide.”

Price is not the only issue; there are four key factors involved in having your products made in China: price, quantity, delivery date and quality and if you fail to hold your Chinese factory legally accountable for all four of these things, you are likely to have problems. If your Chinese supplier takes all four factors seriously, its pricing must increase. Foreign buyers who are not willing to accept such an increase will continually face the Chinese factory failing to comply with the other factors. Quality will suffer, delivery will be short or late, or the factory will suddenly quit accepting orders right at the height of the delivery season.

Risk Three: Low Priority in Production Schedule. The Chinese side accepts your purchase order for a small run of product at a low “China” price. Then another buyer shows up and offers a slightly higher price for a larger quantity of product. The Chinese side then pushes your order down the line for priority and your delivery is delayed. In some cases, the delay extends to the point where delivery never takes place. The Chinese side is not concerned about failing to deliver on the purchase order, since the litigation risks are extremely low because you do not have a Chinese language contract that works. See China Contracts: Make Them Enforceable Or Don’t Bother.

This situation regularly occurs when the relationship is based on “one off” purchase orders. See How To Get Bad Product From China With No Legal Recourse. The way to deal with this issue is to have a contract manufacturing agreement that clearly incorporates your purchase orders into the legally binding contract and that provides specific monetary penalties if your factory accepts a purchase order and then either delays or fails to deliver. When pressed to enter into this sort of agreement, Chinese factories will treat accepted purchase orders seriously and their delay/default rate goes way down. In our experience, factories that intend to take a relaxed view towards their legal obligations under an accepted purchase order will simply refuse to execute a formal contract manufacturing agreement, which is exactly what you want. See How To Write A China Contract. Liquidated Damages.

Risk Four: Sudden and Unpredictable Price Increases. Under the standard scenario, the Chinese side agrees to manufacture your product at a goal price, without ever having undertaken any serious examination of what it will actually take to manufacturer your product. The Chinese side then does the product development and the production implementation. The samples are acceptable and it is time to begin production. The foreign buyer then submits the first purchase order at the goal price. The Chinese side refuses to accept the PO and announces a substantial price increase. If the price increase is not accepted, the factory states that it will not accept any future purchase order.

There are two reasons China factories do this. The first and most common is that the factory never understood the price issue and never planned to meet the proposed price. The factory merely accepted the goal price to prevent you from going to another factory. The Chinese factory assumes you will be compelled to accept a purchase at the “real” price (whatever that price is) because you will be unwilling or unable to spend another 6-12 months (or whatever it will take) to start over with another factory.

The second common reason Chinese factories will take on a product development project with no intention of giving you the product you want at a price and delivery schedule that can make sense is that the factory is treating you as its outsourced R&D center. The idea comes from the foreign side, the implementation comes from the Chinese side. But the ultimate goal is for the Chinese side to make and sell the product on its own. The Chinese factory never planned to make the product for the foreigner. So they offer a very high price. If the foreigner accepts, they make the product for the foreigner at a price higher than they ever imagined. If the foreigner refuses the price, they move on to make and sell the product on their own. This sort of thing is incredibly common and hardly a week goes by without someone calling one of our China lawyers for our help to “require the Chinese factory to get its price in line with the market.” But unless you have a written contract that works for China and made pricing clear, there is nothing we can do to help at that point.

If the foreign buyer is purchasing an off the shelf product that is part of the Chinese factory’s standard inventory, the risk of any price issue is low. If you are engaging the Chinese factory to make minor customization of its standard product (maybe just adding your logo or changing the color), the risk is also low. But if the Chinese factory will be modifying/customizing its existing product, you should have a legally binding contract that the Chinese factory feels compelled to honor. The way to deal with this is under a product development agreement that includes the following three key components:

  • A strict timeline for developing the working prototype.
  • A provision that makes clear you own the prototype and all data, drawings and tooling required to manufacture based on the prototype.
  • A provision that states that if the factory meets the target price, you will purchase exclusively from the factory, but if the factory cannot meet the target price, you are free to take the prototype and have it manufactured at any other factory.

Without an agreement like this, you should expect a price increase as an almost a certain result of the product development process.

In part 3 of this series (coming later this week), I will examine how best to deal with the last three business risks inherent in having your product made in China, including one of my favorites, subcontracting.

 

Myanmar Thailand VietnamRobert Walsh, sometime Seattle resident and long-time friend of our law firm (we worked on a number of China deals together and we — Dan and Steve — met up with him on our last trip to Myanmar), has spent the last four years in Myanmar, where he operates a vibrant business consultancy. Robert is fluent in Chinese and Korean and, amazingly enough, Burmese (multiple dialects), having learned Burmese while working in the U.S. Embassy in Yangon many years ago.

Robert has been sending us email updates from Myanmar for some time and we post some of them on here. Back in 2014, it was Myanmar: Open For Business? and in 2013, it was Myanmar Foreign Investment. Difficult And Expensive, But Opportunities Are There. In our 2013 post I mentioned that my law firm had “been involved in a few Myanmar matters, but truth be told, Myanmar is a difficult place in which to do business and many of the companies going there are bigger companies mostly looking to get in now and make money later. In the last year.” Since that time, our Myanmar work has actually shrunk as interest in Myanmar by SMEs has greatly waned and their non-China Asia focus these days seems to be more on Thailand and Vietnam.

It was nevertheless great to get a bolt out of the blue from Robert this week in the form of a brand new Myanmar update, set forth below.

 

4 years water is under the bridge since we opened up shop in Rangoon.

A bunch of things have changed:

-Sanctions were relaxed, then finally revoked in toto back in October of last year. Now any foreign company that desires to do so can work with any of the formerly blacklisted military crony companies, jade/gems barons, or groups associated with narcotics trafficking. We’re seeing indications that this is happening already.

-Millions more cars on the road, newer Japanese for the most part, but Korean cars have moved in as well, and offer financing. Ford and Chevy are here with local or regional partners; not selling a lot.

-Supply of electricity has gotten steadily better, but this was achieved by a series of band-aid solutions using quickly built gas turbine or heavy fuel oil facilities.

-More places to stay, more restaurants for rich white people. Prices for hotels and rents on apartments have eased up now that supply roughly equals or exceeds demand.

-The November 2015 elections went off without a hitch, with the National League for Democracy (NLD) taking the lion’s share of seats. Daw Aung San Suu Kyi was not permitted to become president, but loopholes were found to allow her an equally powerful position. The finder of that set of loopholes, U Ko Ni, NLD’s senior lawyer, was gunned down outside the arrivals hall at Mingaladon airport last Sunday (January 29, 2017).

-The American Chamber of Commerce has a Myanmar chapter with over 100 members, but I’d say less than a dozen are really active. Sanctions or none, American business has not shown a tremendous interest in this place. Oil & Gas are here, but their presence and local footprint is no larger than it has to be to administer the constellation of service companies that follow in their wake. The only American manufacturer to date is Ball Corp, and they’re here just to make cans for Coke. Coke came in back in 2012 by acquiring a local soft drinks bottler.

-Japanese and Korean business are still by far the biggest foreign presence. Our best guess is that more than 3000 Korean families are here, not all coming out of Chaebol companies, most doing business on their own accounts. If we exclude Americans working for the embassy and USAID contractors, the number of hard-core American expats is probably less than 50.

-The largest sector in which American and European business is represented is what I and others term the “Aid and Development Industrial Complex”. An emerging sub-sector is the “Peace Process Participation Industrial Complex,” which attracts many nicely paid foreign consultants.

The lyrics are different, but the tune’s the same:

-Although the government has supposedly changed hands to civilians, many upper-level ministries out in the provinces don’t seem to have gotten the word, especially if they are headed by ex- (or not so ex-) military people. The farther away from the Naypyidaw flagpole, the more clearly this is evident.

-Laws may pass, but implementing instructions are slow to make it down to where the rubber meets the road.

-Doing anything land intensive requires one take up the diligent study of various land documents issued to owners over the past 160 years. In the fringe border areas, especially where there has been a lot of fighting since independence, land documents are especially puzzling.

-The IFC/World Bank has hosted a “Myanmar Business Forum” (MBF) with eight working groups along industrial sector lines. Its aim was to engage lawmakers and ministries to draft and pass law through the Union of Myanmar Federation of Chambers of Commerce and Industry (UMFCCI). I sat on the agricultural/forestry working group and we were actually able to get things done, in terms of getting implementing instructions for laws passed as long as 20 years ago. The most active working groups were for anything related to land tenure or hotels/tourism. Missing or poorly represented were agricultural finance and inputs (fertilizers, agrochemicals).

– A second set of refinements to the Foreign Investment Laws were passed, but they do not help much. It still costs a lot of money to set up a business here. We have been doing a lot of work setting up companies as rep offices, once we were absolutely sure what the rules were, and what a rep office could/could not do. Most of our clients want our help in establishing a presence, opening a local banking account and administering expat immigration, and setting up shop. NGO’s are our biggest customers, as they now realize that registration as an NGO (as opposed to just a normal for profit company) rarely offers them anything and indeed adds restrictions on their movements and activities — in other words, not so different from China).

-Right now a fairly nasty set of visa and foreigners laws is up for passage. If pass as written, I think many foreigners will stay away or leave if already here. As it stands, many of the laws are currently on the books, and few expats are compliant because the government does not strictly enforce them. Should the government wish to do so, it can deport anyone and everyone who is not compliant, and do so at a moment’s notice. And we do see the government deporting foreigners who do things that excite their ire, usually for political or religious reasons, and occasionally for criminal behavior.

-Like it or not, there is plenty of unrest in this country, and large swathes of Kachin and Shan state are low-boil combat zones; the Kachin Independence Army (KIA) is still far from considering entering the National Ceasefire Agreement. A number of ethnic armed groups have signed the NCA and are now lapping up greenmail money and other territorial benefits, but the majority of them have not in fact been combat effective for a long time, decades in most cases. The KIA has formed a 5-member alliance of other groups that are equally belligerent and unwilling to sign the NCA under the government’s terms.

-In Rakhine state the slow-motion train wreck that is the Rohingya situation shows no sign of resolution anytime soon, and if anything, Trump’s election and anti-Muslim rhetoric has reduced inhibitions on the Burmese taking harsher action to force these people back into Bangladesh. Incidentally, slain NLD lawyer U Ko Ni was himself a Muslim, albeit from a family with generations-back residence in this country. The American embassy used to be pretty shrill in denouncing bad behavior towards the Rohingya, but since Trump’s election the United States has not said so much.