China lawyers
Don’t be a sucker. Translating your contract won’t work.

Every few months someone will write one of our China lawyers asking them to translate an already written contract for China. We always refuse, not just because we are lawyers not translators, but because doing so would be a complete waste of time simply because contracts that work for the United States, Europe, Australia, Canada, etc., simply do not work for China and putting those contracts into Chinese won’t change that.

The other day though, someone who wrote me asking to have one of our China attorneys translate an NNN Agreement into Chinese for him pushed back when I said that our firm has a clear and longstanding policy never to translate contracts (or anything else for that matter). After a couple more emails where I adamantly refused to have my firm do the work, he asked me if I would “just tell him how we arrive at our liquidated damages amount” and “refer him to a really good English-Chinese translator.”

My response to that was as follows:

You can translate your NNN perfectly (and good luck with that) but there is still a 99.99% chance it will be completely ineffective. I say this because I have never seen an NNN that works that has not been written by a very experienced China lawyer. I suggest that you read our most recent two posts on our blog, as those deal with how IP squirts out unless your NNN or other agreement includes provisions preventing them from leaking to these other third parties. This is only one of many ways the NNN you want translated pretty much has to be ineffective.

As for liquidated damages [more properly called contract damages], that is an art not a science and — get this — you have to write this in a specific way because if it is deemed to be a penalty and not a valid and reasonable effort at quantifying damages, no Chinese court will enforce it. In the end the right amount should be based on, among other things, the court’s predilection in the Chinese city in which the disputes will be resolved (as China’s courts are all over the map on this — and you had better choose the right court for your disputes or your contract will be unenforceable), the value of the product at issue, the value of the IP at issue, the size of the companies involved, the type of IP at issue, and, in the end, the most important thing is that the amount be low enough such that the other side will sign it and the court will enforce it. Oh, and one more thing, you need to write this so that you are not limited to just this amount, but so that you are also free to pursue other damages on top of this. The whole point of the contract damages provision is not to get the penalty; it is to prevent the other side from leaking out your IP. The force of this provision is that it allows you to go to a Chinese court (but only if written a certain way) and freeze the assets of the Chinese company. This is the key to getting the Chinese company to stop abusing your IP. This is also the key to this provision; it must be written “just so,” so that the Chinese company believes it is better off not stealing your IP than bearing the wrath of that provision if it does. For more on this, check out this. I have never seen anyone other than an experienced China lawyer get this right.

If despite the above, you want to spend money on translating I don’t think it matters who you use and you really do not need someone who knows legal terminology because you probably have not used the right legal terminology in the English language version of your NNN Agreement in the first place. There are plenty of Chinese translators on UpWork but I cannot recommend anyone because we do not use translators; we use our own Chinese lawyers to draft agreements.

Bottom Line: Translating contracts into Chinese does not make them valid China law contracts, it just doesn’t.

China employment law
China employment: Do it right and you can avoid and win lawsuits. Do it wrong and you will likely pay the price.

Last week in Part 1 of this series, I wrote how when it comes to terminating an employment contract in China, China employment law and its courts do not treat the employee and the employer as equal parties; the employee has much more power than the employer. I also mentioned how an employee in China can leave his or her employ without penalty simply by providing advance notice of the intent to leave, if his or her employer has failed to provide labor protection or labor conditions in accordance with the employment contract.

An employer that unilaterally changes its employee’s position (oftentimes, even ever so slightly) will usually be deemed to have breached the labor conditions in its employment contract.

Let’s take at a recent Shenzhen case in Shenzhen (simplified a bit for this post). In this case, a Shenzhen employer executed an employment contract with one of its employees that provided that the employee’s initial position was engineering technologist and the nature of work was to provide engineering technology services and management. According to the employment contract, the work location was Shenzhen and the employer had the right to adjust the employee’s position, responsibilities and work location according to the employer’s business needs. A few years into employment, the employer decided to have the employee work in a different office building within walking distance from the employee’s previous work location, but still within Shenzhen. The employee’s position was also was slightly modified, but the employee was still an engineer.

The employer served written decision on the employee of the two above ultra-minor changes but the employee did not sign off in writing on the decision, but nor did the employee voice any objections. The employee’s salary did not change.

After these adjustments were made, the employee failed to show up to work for several days in a row and each time, the employer made a disciplinary action against the employee, all according to its employer Rules and Regulations, which had been previously published and which were accessible to all employees. After taking a number of disciplinary actions against the employee for non-attendance at work, the employer terminated the employee in accordance with its employer Rules and Regulations.

The employee then initiated a labor arbitration claim against the employer, demanding (among other things) double statutory severance pay for illegal termination. In situations like this, the employer bears the burden of proof to show the court that the change was lawful.

The employee lost at arbitration and then took the case to court, where he lost again. The employee then appealed to the intermediate court and lost, and then petitioned the Guangdong High People’s Court for retrial and lost yet again, making this one of the rare cases where a China employer won. See China Employment Arbitration: Good Luck With That Battle.

The employer in this case won because it was able to prove ALL of the following: (1) the employment change was necessary for the employer’s operations; (2) the employee’s salary remained roughly the same; (3) the adjustment of the employee’s states was not of an “insulting or punishing nature”; and (4) the employer did not otherwise violate any applicable law and regulations. Most importantly, the employer had written evidence in Chinese backing all of this up. In this particular case, the trial court focused on (2) and (3) above and on how the employee’s salary had not been reduced, on how the employer had not changed the employee’s title or primary responsibilities, on how the employer had followed all of the necessary formalities in giving the employee advance notice and on how nothing indicated that the change for the employee was of an insulting or punishing nature. Perhaps most importantly, the court noted that the employment contract clearly provided that the parties agreed to the employer’s having the right to adjust the employee’s position according to the employer’s needs and the employer had disciplined the employee in accordance with the employer’s written Rules and Regulations.

Because the employer satisfied all of the above tests, it was able to terminate the employee without having to pay any statutory severance even though the employee was on an open-term employment contract. This case shows that though it is anything but easy to terminate an employee in China without incurring a financial penalty, it is possible if you have the proper employment contract and the proper employer Rules and Regulations and you document in writing your actions every step of the way.

Truth be told though, the real reason we are such sticklers for having the right employment contract and Rules and Regulations and right termination actions is not so much so that our China clients can get sued and win, but so that they never get sued at all. If you do everything right with your China employees and you pay them a bit of severance you can almost always get them to sign a binding agreement not to sue and that will — 999 times out of 1,000 cost you way less and take up way less of your time and be way less disruptive for your business than being sued three or four times, even if you eventually prevail.

Either way, doing it right pays off.

China compliance ChecklistWith the last quarter of the year approaching and China increasing its scrutiny of foreign businesses operating in China, now seems like the right time to talk about what such businesses (WFOEs, joint ventures, representative offices) should be doing to protect themselves on the compliance front.

Let me start by saying that if you have familiarized yourself with the applicable Chinese laws and your business has done its utmost to comply with those laws, the odds of your company getting into legal hot water in China are low. My firm has helped countless foreign companies deal with China compliance failures, and very rarely have we concluded that our client was singled out for no good reason. Even when our client had done nothing wrong, we could still understand why the Chinese government had initially thought otherwise.

On top of this, the foreign companies we represent have become much savvier in realizing the need to remain in compliance. It has truly been years since any of our clients have excused their non-compliance by claiming that “everyone is doing it.

But what exactly should you be doing now to ensure that you are in compliance with Chinese laws? The following is a basic list.

Corporate Compliance. Are your company’s activities still covered by the scope of business used during registration? If you registered as an import/export company and you now own a factory, you should make some changes. Is your business in a different location from that listed on your business license? That requires a change also. Is the the person listed as your company’s legal representative still with your company and still the person you want in this position? What about the general manager? The supervisor? Have there been any changes to the parent company?

Employment Compliance. China’s employment laws are complicated, localized, and pro-employee. Make sure you have appropriate written employment agreements with ALL of your employees in China, domestic and foreign. Review and update your employee manual (a/k/a Employer Rules and Regulations). Review and update all other employment-related documents, from offer letters to severance agreements and everything in between. Make sure you otherwise stay in compliance: are all of your non-Chinese employees’ work permits and residence permits up-to-date? Have you secured approval from the local labor bureau for any employees under a non-standard working hours system? Have you secured all necessary renewals for such employees? Are you paying into the appropriate social insurance accounts for each employee?

Tax Compliance. It is essential to engage a competent local accounting firm. Your accountant must of course understand Chinese tax law, but they should also have at least a rudimentary understanding of your home country’s tax laws as well. For instance: make sure your transfer pricing is current and accurately reflected in your contracts and that your profit margins are high enough to keep China’s tax authorities at bay.

IP Compliance. We constantly get calls from foreign companies doing business in China that have let their China IP registrations fall into disorder (or never organized their IP in the first place). Even if you registered everything appropriately when you first came to China, have you kept up with newer products/services or brands? Are you registering design patents before you release your products? Are you keeping sufficient evidence of trademark use to fend off a non-use cancellation? Have you properly drafted and registered any trademark license agreements? Are you taking full advantage of the Chinese trademark system?

Contract Compliance. Many foreign companies do business in China in a way that makes it all but impossible for them to enforce their contractual rights. Do you have written agreement with all your major sources and clients? Are you using a lawyer to draft your design/manufacturing/licensing/purchase/etc. agreements? Are these agreements in Chinese? Enforced under Chinese law?

Spend the time now on the above to avoid having to spend a lot more time later.

China import lawU.S. Customs and Border Protection (CBP) just issued new regulations that establish a new administrative procedure for CBP to investigate antidumping (AD) and countervailing duty (CVD) evasion. Importers of any product that could remotely be considered merchandise subject to an AD/CVD order now face an increased likelihood of being investigated for AD/CVD duty evasion. The new CBP AD/CVD duty evasion investigations are the latest legal procedure, together with CBP Section 1592 penalty actions, CBP criminal prosecutions, and “qui tam” actions under the False Claims Act.  aimed at ensnaring US importers and their foreign suppliers in burdensome and time-consuming proceedings that can result in significant financial expense or even criminal charges.

This almost certainly means Chinese goods subject to AD/CVD duties will be facing increased CBP scrutiny, especially given the political pressure and enflamed rhetoric blaming Chinese imports for the downfall of American manufacturing. Now that CBP has been given another legal weapon to shut down AD/CVD duty evasion, importers (and their Chinese suppliers) should assume CBP will be using this weapon and they need to figure out how to stay clear of these investigations or start preparing to defend themselves.

The following are key points from these new regulations:

  • CBP now has a new option to pursue and shut down AD/CVD duty evasion schemes.
  • Other interested parties, including competing importers, can participate in CBP’s investigation and chime in against the accused importers.
  • CBP will have broad discretion to issue questions and conduct on-site verifications.
  • Certain information that would have been submitted under seal in CBP’s old investigations will now be made publicly available in CBP’s new investigations.
  • CBP investigations may result in interim measures that could significantly affect importers.
  • Failure to cooperate and comply with CBP requests may result in CBP applying an adverse inference against the accused party, including a determination that AD/CVD evasion has occurred.

The new CBP regulations establish a formal process for how it will consider allegations AD/CVD evasion. These new regulations are intended to address complaints from US manufacturers that CBP was not doing enough to address AD/CVD evasion schemes and that CBP’S investigations were neither transparent nor effective.

AD/CVD duty evasion schemes typically involve falsely declaring the country of origin or misclassifying the product (e.g., “widget from China” could be misreported as “widget from Malaysia” or “wadget from China”).  A recent GAO report noted that CBP was unable to collect $2.3 billion of AD/CVD duties from 2001-2014, most of which involved subject merchandise from China.

Petitions filed by domestic manufacturers trigger concurrent investigations by the U.S. Department of Commerce (DOC) and the U.S. International Trade Commission (ITC) to determine whether AD/CVD orders should be issued to impose duties on covered imports. The DOC determines if imports have been dumped or subsidized and calculates the applicable AD/CVD rates.  CBP then has the responsibility to collect AD/CVD duty deposits and to assess the final amount of AD/CVD duties owed at the rates determined by DOC.

US petitioners have decried U.S. Customs and Border Protection (CBP) as the weak link in enforcing US trade laws, not just because of it often being unable to collect the full amount of AD/CVD duties owed, but also because how CBP responds to allegations of AD/CVD evasion. Parties that provided CBP with information regarding evasion schemes were not allowed to participate in CBP’s investigations and were not notified of whether CBP had initiated an investigation or the results of any investigation.

CBP’s new regulations address many complaints regarding CBP’s lack of transparency in handling AD/CVD evasion allegations. The new regulations provide more details on how CBP procedures are to be conducted, the types of information that will be considered and made available to the public, and the specific timelines and deadlines in CBP investigations:

  • “Interested parties” for CBP investigations now includes not just the accused importers, but also competing importers that submit the allegations.
  • Interested parties will be required to submit public versions of confidential Information submitted in CBP’s AD/CVD evasion investigations.
  • After submission and receipt of a properly filed allegation, CBP has 15 business day to determine whether to initiate an investigation and 95 days to notify all interested parties of its decision. If CBP does not proceed with an investigation, CBP has five business days to notify the alleging party of that determination.
  • Within 90 days of initiating an investigation, CBP can impose interim measures if it has a “reasonable suspicion” that the importer used evasion to get products into the U.S.

Many questions remain as to how CBP will apply these regulations to actual investigations.  How exactly will parties participate in CBP investigations and what kind of comments will be accepted?  How much of the information in the investigations will be made public? How is “reasonable suspicion” defined and what kind of evidence will be considered? Is it really the case that accused Importers may be subject to interim measures (within 90 days of initiation) even before they receive notice of an investigation (within 95 days of initiation)?

These new AD/CVD duty evasion regulations further evidence the government’s plans to step up its efforts to enforce US trade laws more effectively. Importers, in turn, must step up their vigilance to avoid being caught in one of these new traps.  Given that a significant portion of the uncollected AD/CVD duties have involved products from China, there is a good chance that US importers and Chinese exporters will be subject to new allegations of AD/CVD duty evasion that may affect their ability to compete in the US market.

China Manufacturing ContractsLast month I wrote about the three basic types of manufacturing agreements commonly used by foreign companies that get their manufacturing from China: Original Equipment Manufacturing (OEM), Contract Manufacturing (CM), and Original Development Manufacturing (ODM). But this apparent simplicity is deceiving because there are three ways this division breaks down in the real world of manufacturing. Our task in China is in dealing with this breakdown of the simple set of distinctions.

Let’s start with a quick review of the three main types of China manufacturing agreements:

  • OEM (original equipment manufacturing): In an OEM arrangement, the factory owns the design.
  • CM (contract manufacturing): In a CM arrangement, the foreign buyer owns the design.
  • ODM (original development manufacturing): In an ODM arrangement, the party that does the development work owns the design. This is usually the Chinese factory.

In the practical world of outsourced manufacturing, these neat distinctions often get blurred. There are three essential ways this happens.

First, when starting out with a manufacturing agreement, our China lawyers always ask our clients which of the three types of manufacturing arrangements (listed above) will apply to their China manufacturing. Often, their answer is “all three.” That is, the client wants a single agreement covering all three types of manufacturing arrangements. Though it is possible to draft a contract that covers all three of these manufacturing relationships, the result is complex.

The problem with this type of complex manufacturing agreement is that it requires the client make a decision with every factory and with every product. The client must specify in each case which of the three categories apply. In working with a single factory, all three of the categories may apply to individual items purchased from that factory. In this kind of complex situation, the tendency is for both sides is to default to a single result. More often than not, that default choice is not appropriate. When the choice is not appropriate, the contract then fails to provide the foreign buyer with adequate protection.

Second, the three categories of manufacturing agreements themselves do not crisply mirror a more complex reality. In an OEM arrangement, the foreign buyer often requires changes to the Chinese factory’s standard product. Who then owns those changes? In a CM arrangement, the foreign buyer often requires the Chinese factory modify the design to make for more efficient production. Who owns the modified product? In ODM, the foreign buyer and the Chinese factory normally work closely together in developing the new design. When two design teams work together, who owns the resulting product?

The third and most interesting situation is when neither side of the transaction actually “owns” anything related to the product’s design. What many on both sides of these manufacturing projects often do not understand is that the ownership implies there is a formal property right. In the world of manufacturing, intellectual property is the applicable concept of property.

There are four basic forms of intellectual property: patent, trademark, copyright and trade secrecy and though there are differences in detail, both China and the United States follow this basic division. Though the parties throw around the term “intellectual property” in discussing the product being manufactured, it is often the case that no form of intellectual property covers the product being manufactured. There may be no patent rights because nobody ever applied for a patent or because applicable patents have expired. Though a trademark may exist, a product design can be copied with the trademark not used on the copied version. Copyright does not cover functional items. Trade secrets either never existed or have been abandoned through disclosure.

This means that the China attorneys at my firm often face a situation where both sides to the manufacturing transaction claim they “own” a design of a product or a manufacturing method when neither side actually does. When we do a careful investigation, we learn neither side owns any formal intellectual property rights in the product design, whether in the base design or in the design innovation. Both the Chinese factory and the foreign buyer are often surprised by this result. In terms of formal intellectual property protection, anyone is free to copy the product design. The factory is free to manufacture the design for others and the foreign buyer is free to have the design made by another factory.

So even though we start with a clear set of concepts, in the real world of China manufacturing, we usually find ourselves in what can be a confusing mess. How do we get out of this mess? With a contract or a series of contracts that set out clear solutions accepted by both sides of the transaction.

That is, both the foreign buyer and the Chinese factory must understand that there is NO default answer to any of the key issues concerning the right to manufacture. This is yet another reason why a simple purchase order approach virtually always fails when having products made in China. Purchase orders assume an underlying set of clear rules when there are in fact no clear rules. The parties have to make their own rules by using clear contracts that force them to face the issues and make and document their decisions on those issues.

China entertainment lawProtection of IP is an ongoing concern for foreign businesses with projects or investments in the entertainment business in China. Many foreigners mistakenly believe their intellectual property cannot be protected at all in China so they overlook or disregard the protections available to them under Chinese law. In response to these concerns and beliefs, the UK Government, the British Film Institute and the Producers Alliance for Cinema & Television (PACT) recently collaborated to prepare a new UK-China Film & TV Toolkit.

The Toolkit includes a template, special-purpose non-disclosure agreement for use by UK film and TV businesses when dealing with their Chinese partners. Also included are detailed explanatory notes guiding UK businesses on the applicable principles of confidentiality, copyright and trademarks under PRC law. The template NDA forming part of the Toolkit was prepared according to PRC law and practice and is bilingual. It is hoped that the Toolkit will allow its users to avoid common pitfalls, including those arising from inappropriate choices of law and jurisdiction.

In liaison with Tom Duke, the UK’s Intellectual Property Attaché to China, our China entertainment law team represented the UK Government, the BFI and PACT on the project and prepared the NDA and the explanatory notes making up the Toolkit.

Intended users of the Toolkit include creative companies, producers, sales companies, VFX houses, and service providers such as film studios and consultants operating in the UK film or TV industries. The Toolkit is intended to assist these businesses to protect themselves when they disclose creative materials or commercial information, especially during the initial phase of negotiations during which an appropriate deal structure needs to be worked out. In general the Toolkit will encourage creative collaboration and openness in business dealings.

Among other things, the Toolkit covers the following:

  • How China’s confidentiality and trade secret laws differ from those of common law jurisdictions such as the US and the UK
  • The basic requirements for protecting trade secrets in China
  • The limits to protection and how protection can be lost
  • Why contracts with Chinese parties should always be bilingual
  • Why Chinese law and jurisdiction should be chosen in most instances
  • How protection under an NDA should be supplemented by trademark and copyright registrations in China

Baroness Neville-Rolfe, the UK’s Minister of State for Energy and Intellectual Property, has been visiting  China this week. The visit program has included high level bilateral meetings, policy exchanges and external stakeholder events. The visit will culminate in The UK-China IP Symposium in Beijing on Friday August 26th. The Symposium marks the 20th year of UK Intellectual Property Office cooperation with China’s State Intellectual Property Office (SIPO). As the flagship UK-China IP event, the Symposium will be co-hosted by Commissioner Shen Changyu of SIPO and Baroness Neville-Rolfe.

The Toolkit will be launched officially at the Symposium. I will introduce the Toolkit in a special session of the Symposium and explain how it will help protect intellectual property and encourage creative collaboration. There will also be sessions on promoting innovation through patents and designs and on the UK’s IP enforcement strategy to 2020. To reserve a place at the Symposium please contact Shi.Hui@fco.gov.uk.

For further information about the Toolkit please contact the BFI or PACT.

China labor lawGenerally speaking, a China employee must be employed under a written employment contract. Such a contract may be for a fixed or an indefinite term. When it comes to unilaterally terminating the employment contract, China employment law does not treat the employee and the employer as equal parties; the employee has much more power than the employer. An employee in China can usually leave his or her company without any penalty simply by providing an advance notice of the intent to leave. Furthermore, China employees may terminate their employment contract without even having to give advance notice under any of the following circumstances:

  1. The employer fails to provide labor protection or labor conditions in accordance with the employment contract.
  2. The employer fails to pay in full or on time.
  3. The employer fails to pay social insurance.
  4. The employer Rules and Regulations do not comply with relevant laws or regulations, damaging the employees’ rights and interests.
  5. The employment contract is invalid because of any of the following: (a) the employer used deception or coercion, or took advantage of the employee’s difficulties, to cause the employee to conclude the labor contract, or to make an amendment thereto, that is contrary to the employee’s true intent; (b) the employer disclaims its statutory responsibilities and precludes the employee’s rights, or (c) the employment contract violates mandatory provisions of the laws or administrative regulations.
  6. Other circumstances provided by China’s laws or administrative regulations that permit the employee to unilaterally terminate an employment contract.

China’s Labor Contract Law makes clear that if an employer forces an employee to work by resorting to violence, intimidation or illegal restriction of personal freedom, or if it gives instructions that violate China rules or regulations, or if it orders an employee to perform a hazardous operation that endangers the employee’s personal safety, the employee may unilaterally terminate the employment contract immediately without having to provide notice to the employer.

Note that if your employee terminates the employment contract under one of the circumstances above, (even though your employee initiated the termination) you as the employer must pay statutory severance according to Chinese law.

Number 1 above — “The employer fails to provide labor protection or labor conditions in accordance with the employment contract” — is broader than most foreign employers imagine and it is the one that most often gets foreign companies in trouble. For example, if you as an employer require one of your employees to stop working or to take a vacation, it may be treated as failing to provide labor conditions in accordance with the employment contract.

You may also be deemed to have failed to provide labor conditions under the employment contract if you unilaterally change your employee’s position, and yes even by a promotion. Our China lawyers often see something like the following: a foreign employer modifies an employee’s position and changes the employee’s salary to reflect this. The employee thinks the employer’s decision is unreasonable and refuses to take up the duties of the new position. Either the employee terminates the employment contract and demands statutory severance, claiming their resignation is due to employer abuse, or the employer terminates the employee for failing to follow the employer’s orders or for failing to abide by the employer’s Rules and Regulations.

In either of these situations, the employer must be able to answer this important question: Was the change lawful? The employer (and not the employee) has to answer this question because the employer (and not the employee) bears the burden of proof. In other words, the employer must prove that its change was lawful.

An employer must usually be able to prove that it fulfilled a number of conditions to “walk out free” from monetary punishment or being required to reinstate the terminated employee, and like just about everything related to China employment law, these conditions vary depending on the locale. For example, in Guangdong Province, the employer must be able to prove ALL of the following to be able to avoid sanction: (1) the employment change was necessary for the employer’s operations, (2) the employee’s salary remained roughly the same as his or her pre-adjustment salary (whatever that means!?), (3) the adjustment of the employee’s job status was not of an “insulting or punishing nature,” and (4) the employer did not otherwise violate any applicable law and regulations.

When we work with employers in Guangdong (and everywhere else in China, for that matter) we also recommend that their employment contracts have a provision clearly stating that the employer has the right to adjust the employee’s position according to the employer’s business needs.

Bottom line: Your employee is not “stuck” with you just because he or she signed an employment contract, though the same is not true for you as the employer. There are a number of circumstances under which your employee can choose to leave your employ without giving prior notice. And if he or she alleges their leaving your employment was because of employer abuse and you cannot prove otherwise, you will face adverse consequences.

In China, that’s just the way things go….

China lawyersOne common mistake U.S. companies make is failing to understand that patents and trademarks are territorial.* That is, these forms of intellectual property only provide protection in the country in which they were registered. This means that trademarks and patents registered in the United States offer no protection in China. If a U.S. company has not registered its patents and trademarks in China, a Chinese company is free to make use of that intellectual property in manufacturing or selling the product in China. The U.S. owner of the intellectual property will call these products “knock-offs” or infringements, but the manufacture and sale of those items in China and from China is perfectly legal. Though selling those products in the United States will be prohibited, selling them in a jurisdiction where there has been no registration is also perfectly legal. To put this a bit differently, if you register your patents and trademarks in just the United States, a Chinese company will be free to make your products in China and sell them in China and elsewhere around the world.

This then leads to the following situation we often encounter in China. A U.S. manufacturer has its patented and trademarked product made in China under a contract manufacturing arrangement. The U.S. manufacturer does not register its trademark in China. The U.S. manufacturer does not register patents in China. And the U.S. manufacturer does not enter into a formal contract manufacturing agreement with the Chinese factory concerning ownership and use of the intellectual property in the manufactured items. When asked, the U.S. buyer explains that registration/contracts in China are not necessary because the U.S. trademark and patent mean no knock offs can be sold in the U.S. The manufacturer feels perfectly safe.

Then consider what happens. Say the product being manufactured in China is after market auto parts for U.S. automobiles. The Chinese manufacturer is aware that it is not possible to sell knock off parts in the United States. However, the Chinese factory also knows there is a huge market for used U.S. autos and small trucks in S.E. Asia, India, the middle East and Africa. Since the autos are used, the market for after market auto parts at cheap prices is also huge.

So the Chinese factory does the following in China:

  • Registers the trademark and logo of the U.S. entity.
  • Registers the design patents on each of the parts.
  • Registers the trademarks and design patents with Chinese customs.

Then the factory makes the parts using the exact molds and know-how transferred to the factory by the U.S. entity. Though the parts are technically “knock offs,” they are in reality virtually identical to the genuine parts being sold in the U.S. For this reason, the parts sell extremely well in non-U.S. markets. The Chinese factory then builds a major market selling these parts outside the U.S. Since no trademarks or patents are registered in these third-world markets, the sales do not violate any laws.

And because these parts are so good, they also just happen to find their way into the U.S. as well, sometimes using the trademarks, but more often under a different name.

Eventually, the U.S. company finds out about its Chinese factory’s “side door” sales program and instructs the Chinese factory to cease manufacturing “its” auto parts. The Chinese factory refuses, so the U.S. company threatens to move its manufacturing to a different factory in China. The Chinese factory then calmly tells the U.S. company the following: “You cannot switch your manufacturing to another factory in China because we own the trademarks and patents in China (in those situations where the U.S. company has not registered its patents in the U.S. or in China) in China, making manufacturing by anyone else of your products here in China illegal. In addition, if you attempt to export, we will have China customs block those exports from leaving China because they violate our China trademark and patent registrations. If you want to manufacture at all in China, you must continue to use us for that manufacturing.”

U.S. companies and their domestic legal counsel tend to think the only law in the world that counts is U.S. law and that the only market in the world that counts is the U.S. market. That kind of narrow thinking leads to disasters like the one I just described, which our China lawyers see constantly. This kind of result can be avoided by taking seriously Chinese laws and regulations and the reality of world markets.

* This post is focused on U.S. companies not because we believe U.S. companies are the only companies in the world, but because the above sorts of problems are more prevalent among U.S. companies that come to us, as opposed to European or Australian or even Canadian companies. And, perhaps more importantly, these problems are far more prevalent among U.S. lawyers than among lawyers from any other country of which we are aware.

China lawyers for counterfeitsWith Amazon and Ebay having increased their efforts at bringing in Chinese sellers and with more and more Chinese manufacturers branching out and making their own products, the number of companies contacting our China lawyers about problems with counterfeit products and knockoffs has soared. If the problem involves infringing products being imported into the United States, powerful remedies are available to companies with US IP rights. One of the most powerful remedies is a Section 337 case, which can block infringing products, regardless of their origin, from entering the U.S.

A Section 337 action (the name comes from the implementing statute, 19 U.S.C. 1337) is available against imported goods that infringe a copyright, trademark, patent, or trade secret. But because other actions are usually readily available to owners of registered trademarks and copyrights, Section 337 actions are particularly effective for owners of patents, unregistered trademarks, and trade secrets. Although generally limited to IP rights, in the ongoing Section 337 steel case, US Steel has been attempting to expand the definition of unfair acts to include hacking into computer systems and antitrust violations.

The starting point is a section 337 investigation at the US International Trade Commission (“ITC”).  If the ITC finds certain imports infringe a specific intellectual property right, it can issue an exclusion order and U.S. Customs will then keep out all the infringing imports at the border.

Section 337 cases have been brought and exclusion orders issued against a vast range of different products: from toys (Rubik’s Cube Puzzles, Cabbage Patch Dolls) to footwear (Converse sneakers) to large machinery (paper-making machines) to consumer products (caskets, auto parts, electronic cigarettes and hair irons) to high tech products (computers, cell phones, and semiconductor chips).

Section 337 is a hybrid IP and trade statute, which requires a showing of injury to a US industry. The injury requirement is very low and can nearly always be met–a few lost sales will suffice to show injury. The US industry requirement can be a sticking point. The US industry is usually the one company that holds the intellectual property right in question. If the IP right is a registered trademark, copyright or patent, the US industry requirement has been expanded to not only include significant US investment in plant and equipment, labor or capital to substantial investment in the exploitation of the IP right, including engineering, research and development or licensing.  Recently, however, the ITC has raised the US industry requirement to make it harder for patent “trolls” or Non Practicing Entities to bring 337 cases.

Section 337 actions are fast, intense litigation in front of an administrative law judge (ALJ); The typical section 337 case takes only 12-15 months. Once a 337 petition is filed, the ITC has 30 days to determine whether or not to institute the case. After institution, the ITC will serve the complaint and notice of investigation on the respondents. Foreign respondents have 30 days to respond to the complaint; US respondents have only 20 days. If the importers or foreign respondents do not respond to the complaint, the ITC can find the companies in default and issue an exclusion order.

The ITC’s jurisdiction in 337 cases is “in rem,” which means it is over the product being imported into the US. This makes sense: the ITC has no power over the foreign companies themselves, but it does have power over the imports. What this means in everyday terms is that unlike most regular litigation, a Section 337 case can be effectively won against a Chinese company that 1) is impossible to serve, 2) fails to show up at the hearing, and 3) is impossible to collect any money from.

The remedy in section 337 cases is an exclusion order excluding the respondent’s infringing products from entering the United States. In special situations, however, where it is very easy to manufacture a product, the ITC can issue a general exclusion order against the World. In the Rubik’s Cube puzzle case, which was my case at the ITC, Ideal (the claimant) named over 400 Taiwan companies as respondents infringing its common law trademark. The ITC issued a General Exclusion Order in 1983 and it is still in force today, blocking Rubik’s Cube not made by Ideal from entering the United States. In addition to exclusion orders, the ITC can issue cease and desist orders prohibiting US importers from selling products in inventory that infringe the IP rights in question

Section 337 cases can also be privately settled, but the settlement agreement is subject to ITC review. We frequently work with our clients to settle 337 cases early to minimize their legal fees. In the early 1990s, RCA filed a section 337 case against TVs from China. The Chinese companies all quickly settled the case by signing a license agreement with RCA.

Respondents caught in section 337 cases often can modify their designs to avoid the IP right in question. John Deere brought a famous 337 case aimed at Chinese companies that painted their tractors green and yellow infringing John Deere’s trademark. Most of the Chinese respondents settled the case and painted their tractors different colors, such as blue and red.

Bottom Line: Section 337 cases are intense litigation before the ITC, and should be considered by U.S. companies as a tool for fighting against infringing products entering the United States. On the flip side, US importers and foreign respondents named in these cases should take them very seriously and respond quickly because exclusion orders can stay in place for years.

Getting your product made in ChinaYou are a new company just starting out. You have a great product and you have no other options but to have your product made in China, a country to which you have never been and know little to nothing about. What do you do?

You essentially have two choices. You bring in and pay a person or a company to help you find the right Chinese manufacturer or you do it yourself. Both of these have their pros and cons but in our experience, using an intermediary tends to be riskier, and that need not be the case. If you were to understand the role of your intermediary and work to smooth out the rougher edges of that role, you could make using one no riskier than going it alone.

In working with an intermediary to get your products manufactured in China, you must understand how you are paying them and even how much. There are multiple ways to pay these intermediaries, including the following:

1. You pay the intermediary an upfront flat fee for the intermediary to, among other things, find you a China manufacturer and to negotiate with the China manufacturer on your behalf. Typically, in this sort of arrangement, the intermediary drops out after you place your first order and that order is completed. The biggest pro to this method is that you pay once and the intermediary has less incentive to permit the China manufacturer to overcharge you. The biggest con is to this method is that you must come up with a large chunk of money right away and it is still possible (and not all that uncommon) for your intermediary to strike a side deal with your China manufacturer to get a 5-40%+ secret commission on every sale. If your intermediary does have a side deal with your manufacturer, it also has incentive to use a too-cheap manufacturer so as to be better able to hide its secret commission from you. Too-cheap manufacturers are more likely to have quality control and delivery problems.

2. You pay the intermediary by the hour to, among other things, find you a China manufacturer and to negotiate with the China manufacturer on your behalf. In this sort of arrangement, it is not uncommon for the intermediary to remain on board indefinitely to help with quality control issues. The pros and cons of this payment method are similar (though a bit reduced in terms of the upfront payment) to the pros and cons of method one.

3. You pay the intermediary some percentage on top of what the China manufacturer charges. In this sort of arrangement, it is typical for the intermediary to find you a China manufacturer, negotiate on your behalf with the China manufacturer, and remain on board indefinitely to help with quality control and to keep collecting the percentage payment. The biggest pro to this method is that you do not have to pay anything up front. The biggest con to this method is that it seems like 90% of the time when our China lawyers have been called in on one of these once problems have arisen, we discover that the intermediary’s 5% commission was actually anywhere from 20% to 300% — yes 300%. Again, to the extent your intermediary is hiding the amount of its commission from you, it has incentive to use a too-cheap manufacturer, which heightens your risk of quality control and delivery problems.

4. You pay the intermediary some predetermined fixed amount for your widgets and the intermediary steps in and essentially becomes the seller. This means that the intermediary is clearly responsible for quality control issues and — if you have an appropriate contract with this intermediary, this also means that the intermediary is legally liable for bad quality and late deliveries, etc. The biggest pro to this method is that it is usually the most honest. You know what you are paying for your widgets and the intermediary does not lie to you about what it is paying for your widgets because that figure is irrelevant. When I buy cheese at my grocery store for eight dollars, I hardly care what my grocer paid for the cheese and no representations about what it paid are being made. If the cheese is bad, the grocer is on the hook, plain and simple. But, I am no doubt paying more than if I were getting my cheese straight from the dairy farmer.

We have seen competent and incompetent and legitimate and illegitimate intermediaries use all four methods. Is going it alone better? Much of the time it is, but certainly not always. When is it best to go it alone and when is it best to use an intermediary? Answering that would take a book and we as China lawyers are not the right people to write that. In the end, you pretty much just have to trust yourself and your own comfort level.

BUT, no matter whether you go it alone, there are certain things you can do to reduce your chances of problems. On what problems should you focus and how can you minimize those problems? I will discuss these issues in parts 2 and 3 of this mini-series.