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.

Though it is getting more difficult and expensive for foreign companies to do business in China, China’s burgeoning wealth means the number of companies wanting to sell one shirt to 1 percent of China’s middle class just keeps increasing. Many of those companies are realizing that one of the easiest ways to accomplish that is via their own distributer in China. See That’s Hot: China Distribution Contracts. One of the most common questions posed to our China attorneys about distribution relationships in China is whether they need to be exclusive or not. Oftentimes, these are not even in the form of a question, but rather the potential client or client telling us that they will be giving their distributor an exclusive for all of China because they “understand” the Chinese government requires that.

As we wrote in China Distribution Agreements: Exclusivity Is NOT Required, this is simply not true. Unfortunately, Chinese companies frequently claim this and sometimes even get away with it, sometimes with disastrous results for the foreign company.

Let me explain.

There is no exclusivity requirement in China. None. Nada. Zero. Zilch. 没有.

This means you can have five distributors of your product or in just Shanghai if you want, and then add ten more later. This means you can have an exclusive distribution relationship with one distributor for all of Shandong Province and still have ten distributors for just Beijing. You are legally free to do what you want when it comes to exclusivity in your distributor relationship in China; you are constrained only by the deal you are able to make.

Oh, and one more thing, Chinese companies love to use the term Greater China in their distribution contracts with foreign companies as many foreign companies do not realize that includes Hong Kong and Taiwan and Macao. So be careful about that also.

China Foreign PolicyForeign Policy Magazine just came out with an exceptionally clear-headed, exceptionally valuable article on the derivations/influences of China’s foreign policy, entitled (in part and when you see the full title you will probably understand why I shortened it) How China’s History Shapes its Policies Today.

I posted it on our China Law Blog Facebook page with the following lead-in:

Great article by some truly great people. Read it. Study it. This is the sort of article that could become seminal for understanding China foreign policy. Then read it again.

Not much more to say about it other than that if you have any interest at all in China foreign policy, in China’s place in the world, or even in China at all you need (yes need, not should) go read it. Now. Oh, okay, I cannot resist: Those who cannot remember the past are condemned to repeat it.

Your thoughts?

China Trademarks
by Meaghan O’Malley. http://bit.ly/2nE4kcw

The Boston-based hamburger chain Wahlburgers, founded by Hollywood star Mark Wahlberg and his brothers, recently announced plans to open three restaurants in China, with an ambitious goal of opening up to 100 restaurants in China over the next ten years.

The project was announced as a joint venture between Wahlburgers and the Shanghai-based Cachet Hospitality Group. I have no opinion on the deal Wahlburgers struck (aside from a general lack of enthusiasm for joint ventures), but I do have an opinion about their trademark protection: they don’t have enough.

According to the Chinese Trademark Office website, the only trademark registration for “Wahlburgers” is in Class 43 for restaurants (餐馆). Yes, covering restaurant services is essential, but it’s really the bare minimum, and almost certainly won’t provide as much protection as Wahlburgers would want.

To understand why, it’s important to realize how the Chinese trademark system works. With few exceptions, a trademark registration for goods or services in a particular subclass only provides protection for that particular subclass. That’s a double-edged sword. It means that you don’t have to worry about your trademark being rejected because someone else has a confusingly similar trademark in another class (or even another subclass within the same class). But it also means that your trademark registration won’t prevent third parties from registering your exact trademark in other classes.

Here, Wahlburgers should have filed a trademark application to cover not only restaurants but also food. Their trademark registration prevents third parties from operating a restaurant called Wahlburgers, but has zero effect on anyone calling their hamburgers “Wahlburgers.” Moreover, anyone else could register the trademark “Wahlburgers” to cover hamburgers and other food, and then use the tagline “Home of the Wahlburgers®” on their menu and in their advertising. I’m sure that wouldn’t sit well with the Wahlbergs or with their Chinese partners.

It’s possible Wahlburgers was under an actual or imputed contractual constraint, as the US registration for “Wahlburgers” had already been licensed from Tom Wahl’s, a Rochester, NY-based hamburger chain whose website proudly proclaims it is “Home of the Wahlburger®.” But any dispute about who had the right to file trademark applications in China should have been sorted out quietly before holding a press conference to announce that Wahlburgers would be opening branches in Shanghai, Hangzhou, and Wuhan. If Chinese trademark squatters haven’t already filed applications for Wahlburgers to cover hamburgers and other food, they will soon.

It’s 2017. American companies going to China need to get their trademark act together. When you’re filing for trademarks in China, don’t think that the same rules apply as in the United States. Operate within the system as it actually is, not as you think it ought to be.

China contract lawyersIn my first post in this series (here), I described the five basic attitudes Chinese companies have regarding advanced equipment being sold into China.  In part 2 (here), I set out two of five tactics high value equipment sellers should follow when selling advanced (and therefore expensive) equipment into China: One, do not discount, and two, get paid before you deliver your equipment to your China buyer.

In this, part 3, I wrap up this series by setting forth the remaining three tactics equipment sellers should employ when selling their equipment to Chinese companies.

3. Do not deliver the equipment until first verifying that the conditions for its installation have been met. Remember that the Chinese side believes your equipment works based on an almost “magic” formula and your rules on how to set up for its installation and the specifications for its use are just a subterfuge you use to “hide the magic.” The detailed set up work is therefore unnecessary. Meeting the specifications is not necessary. So the Chinese side will not do the proper set up and they will ignore the specifications. But then when your equipment does not work as it was supposed to, the Chinese side will blame you for its failures.

The following are two (of many) true stories that illustrate how this typically goes down:

  • A heavy equipment manufacturing company delivers iron pipe casting equipment. The conditions of sale provide that the floor of the casting room must be perfectly level. When the equipment is delivered, the casting room has an uneven dirt floor. The casting machine does not work and the Chinese side does not pay a single penny on the contract. The Chinese bank that guaranteed the payment sides with the Chinese buyer. Why create a level, clean concrete floor for a dirty machine used for metal castings, one of the China company’s engineers asked at one point.
  • A water power equipment manufacturing company delivers a new hydropower generation set of equipment. The specifications provide that the current flow can never exceed 6 knots. When the equipment is delivered, the Chinese side installs it in an unapproved location where it is well known the current exceeds 8.5 knots. Within one year, the entire facility is destroyed. The Chinese side defaults on the last payment and the reputation of the foreign company is destroyed. The foreign company lost money on the project and never did another sale in China.

Foreign equipment sellers cannot rely just on clear contractual specifications and then relying on the specifications when there is a problem. The foreign seller should itself ensure the conditions are met before it delivers the equipment. And if the conditions are not met, the foreign seller should not deliver. If there is a cost in confirming your Chinese buyer has met the specifications (and there usually will be), you should build that cost into the cost for your product. Remember: the failure of the installation is always your fault and the Chinese side will always find a way to make you pay for that failure. We have said this before and it made people mad, but some of our most experienced and sophisticated and successful China essentially charge a premium to Chinese buyers simply to cover themselves in advance against these sorts of problems.

4. Build required training and after sales maintenance and support into the price of the equipment. No matter how much your potential Chinese buyer tries to get you to decouple the pricing for maintenance and support (and then eliminate it entirely) do not make these optional add-ons that are billed for an additional fee. If you make these optional and charge extra for them, the Chinese side will almost always choose not to pay. So you have to force them to accept training and support as part of your sales price.

Why do the Chinese refuse to pay? Your trying to require them to pay for after sales maintenance is just you admitting that your product is somehow defective and why should they buy a defective product. If properly manufactured your equipment should work forever, with no service or maintenance required and your trying to make the Chinese side pay for training and service as an add-on is you unfairly seeking to increase the price of a product that is already unfairly expensive.

There is one exception related to training. If the Chinese side is planning to clone your equipment, they will seek extensive training in how the equipment operates. Their goal though is not training; their goal is to somehow obtain the formula that will allow them to clone your machine. For this reason, you should carefully control your training with Chinese companies.

During training, the Chinese side will ask for more information and more training time than is necessary. They will also insist on visiting the U.S. manufacturing facility and they will expect to spend substantial time in that facility. For this reason, all training obligations must be carefully defined to prevent your costs from skyrocketing out of control. You should carefully limit time, location and access to information. One good way to control this is to require the Chinese pay by the hour for all training provided in excess of the basic training included in the purchase price.

Many foreign equipment suppliers say they will provide whatever training proves “reasonably” necessary. This sort of an approach is nearly always a mistake because neither Chinese companies nor Chinese courts truly understand or employ the concept of reasonable. You therefore should state state with precision the training you will be providing, where you be providing it, who will be providing it, and for how many hours you will be providing it. The same rules apply to provision for after sales support. Chinese companies tend to abuse after sales support obligations. So those obligations should also be spelled out clearly in your contracts as well. Again, I base this not on any “feelings” I have about China, but based on my having represented countless foreign equipment sellers on countless China equipment transactions and on what I have heard from other equipment companies and from other China lawyers who represent them.

5. Protect your IP through with a China-centric contract. Protecting the intellectual property you have in the advanced equipment you sell into China should be a core goal in all of your sales. Understand the basic approach from the Chinese side: your product is too expensive and b) any form of IP protection is just a unfair device you are using to force them to pay the unfair price of the machine. So the goal of the typical Chinese company is to purchase one or two items at a bargain price and then clone them in China at a “fair” price.

The obvious way to protect the intellectual property in your advanced equipment is to register your patents in China. But for various reasons (including time bars) this is often not possible. Where there is no patent registration (and oftentimes even when there is), your best solution is to incorporate basic IP protections into your sales agreement. This is essential for China.

To accomplish this, either your sales contract or a collateral agreement must provide for the buyer agreeing to the following:

  • Buyer will not reverse engineer or manufacture a copy/clone of the product or engage any affiliate or third party to do the same. A complex legal definition is not required. A blunt, simple statement (in Chinese) is what is required.
  • Define confidential information information (such as the information you provide in training and support) and require no confidential information can be used by your buyer or by any affiliate or by any third party to infringe on your product.
  • Provide for monetary damages if these restrictions are violated. Injunctions rarely work in China, so contract damages are required.
  • Impose these restrictions with a written agreement enforceable by litigation in China. This is a key requirement. Your English language sales agreement that is enforceable in the New York or in London or in Geneva is not going to be helpful in protecting your IP and if it makes sense for you to use that sort of agreement on the sell side (and sometimes it does), you should have a separate IP protection agreement in Chinese, subject to Chinese law and enforceable by litigation in China.

China employment lawyerThis is the first of a two part series on why it has become so important to comply with China’s labor and employment laws and how best to make sure your company is in compliance. In this first part, I briefly explain what has changed in China to make employer compliance — especially for foreign companies doing business in China so important. And in part 2, I explain what our China employment lawyers do by way of Human Relations audits to ensure our clients are in compliance.

Over the last few years China and Chinese employees have become serious about enforcing China’s labor and employment laws. I defy you to find any foreign employer in China that has not had their employer decisions legally tested in the last few years. And thanks to a new law called Measures of Public Disclosure of Significant Violations of Labor Protection Laws that took effect on January 1, 2017, China employers that violate China’s labor protection laws face the additional threat of being “named and shamed.” The following violations of China’s labor laws may be made public by the relevant labor authorities:

  • Failing to pay “substantial” employee remuneration
  • Violating the laws on working time or rest or vacation and the circumstances are “serious”
  • Violating any child labor laws
  • Failing to pay employee social insurance and the circumstances are “serious”
  • Violating the special rules on protecting female workers and underage workers and the circumstances are “serious”
  • Causing significantly bad social consequences due to violations of labor laws
  • Other serious illegal conduct

Like pretty much everything related to China’s employment laws, enforcement of these naming and shaming measures is going to depend on the locale. Guangdong Province, for example, has been disclosing labor authorities’ rulings on employer violations even before the new law was implemented. According to Guangdong published rulings for the first three quarters in 2016, the first three violations mentioned above: (1) failure to pay employee remuneration, (2) overtime law violations and (3) using child labor have been the most common illegal practices. Labor authorities are cracking down particularly hard on employer failure to pay employee remuneration.

What is considered a “substantial” failure to pay? If you owe 10 employees wages, you will no doubt be penalized and your violation will be made public. If you owe one employee a substantial amount (could be as low as 20,000 RMB), you may be listed as well. In other words, the threshold is not terribly high, especially for foreign companies whose employee wages tend to be higher. And since the labor authorities have gobs of discretion in deciding whom to name and shame, we are expecting foreign companies to get less slack. Egregious violations subject employer companies and the person-in-charge to criminal liabilities. Failing to pay substantial employee remuneration is a crime and will be prosecuted. This is not something you want to get wrong.

So if you employ anyone in China, now is the time for you to get compliant. In tomorrow’s post, I will set out our method for accomplishing that.

Editor’s Note: Whenever we write something related to ensuring compliance with China’s employment laws, companies with no legal entity in China contact us “to get into compliance.” If you have “employees” in China but no company in China, your problems go way beyond what is written above. For how to handle that sort of situation, you should check out Doing Business in China with Deportation or Worse Hanging Over Your Head and follow and read the links in that post. Now!

China contract lawyersIn my previous post in this series (here), I described the five basic attitudes Chinese companies have regarding advanced equipment being sold into China. Given these attitudes, what should a foreign seller do? In this part 2 post I set out two of five tactics high value equipment sellers should follow when selling advanced (and therefore expensive) equipment into China. In part 3, I will wrap it up with the remaining three tactics.

1. Do not discount. The first mistake most Western companies make when selling their high end equipment to China is to discount its price. The usual explanation my clients give me for doing this is that “we will discount the first equipment sale and then make up for that discount on future sales.” Wrong.

If you offer a discount you are simply confirming the China side’s basic assumption that your price is too high and you will virtually never get the opportunity to make up for the discount. The Chinese side will do one of two things. Some buyers (especially state owned enterprises or SOEs) will treat the initial discounted items as “samples” they will distribute to other enterprises to be cloned in China. For other buyers, the discounted price will treated as a new floor price for the product. If additional purchases are discussed, the Chinese company will then ask for an additional discount against your already discounted price.

It is therefore critical you hold the line on price. You may perhaps offer a very small quantity discount for purchases of multiple units. You may even offer a small “customer loyalty” discount for return purchases. But never offer a major discount for the initial purchase. Hold the line and explain that your price is both fair and the same price you offer to everyone in the world, on the same terms. What reason is there to change this policy for China?

2. Get paid before you deliver. For companies that are successful in selling to China, this is the golden rule. There really is no alternative. In many countries, issues related to payment can be resolved through the use of carefully drafted letters of credit. Chinese buyers, however, will only use Chinese banks for their letters of credit and those banks will always favor their Chinese buyer customers, so the letter of credit approach will not work for China.

For Chinese companies planning to clone your equipment in China, paying you by installments fits perfectly into their plan. The standard approach works as follows. Set up a system with five installment payments. The equipment will be delivered and installed in stages, in accordance with the installments. Then, the Chinese company will delay payment from the very start and then use the payment delay (which it will usually blame on China’s capital controls or some tax issue) to push the foreign side to deliver more than is required for each installment. The Chinese company will then reluctantly make a payment or two, all the while extracting equipment, training and know-how. When the Chinese side thinks it has gained  “enough” from what you have already provided it, the payments stop. The common standard is to make two of five payments in exchange for 50% of the product and expertise. Our China lawyers warn our clients about this all the time and yet it just keeps happening.

Other Chinese companies will use installment payments to force you to discount. The Chinese side will negotiate for a series of installment payments with a major final installment to be paid after installation and approval by the Chinese side. This approach virtually never works well for the foreign seller as Chinese companies are expert at finding problems with the equipment. The Chinese side will raise these problems as excuses for continual payment delays and then use their own delays to seek an after the fact discount in price from you, while holding the installment payments as hostage to achieve this goal.

If the Chinese company is unable to secure its desired discount from you during the basic installment period, it simply will not make the final payment, achieving a 10% to 15% discount by that single refusal to pay. If the foreign side threatens to sue for that final payment, the Chinese side will trot out a list of problems with the product and its installation — normally problems the Chinese company itself caused. However, this will still be enough to convince the foreign side seller that it will need to mount a long and expensive legal battle to get that final payment and that doing so probably will not make sense.

It is important to note that these tactics by Chinese companies are not unusual. Your price is too high, so they do not see themselves as acting unethically; they are just leveling the playing field. I have spent about half of my life in China and I have heard this reasoning about once a month while there.

China lawyersDoes the Chinese company with which you are doing a deal have a United States subsidiary? Does this mere fact make you feel better about doing a deal with its China parent company? Why? Do you not realize that it is likely to be legally irrelevant?

The always excellent, always informative, Hague Law Blog (by Aaron Lukken) wrote about this in the context of service of process in its post, You can’t simply serve a U.S. subsidiary. Aaron starts out by discussing how you need a compelling reason to “pierce the corporate veil” of a subsidiary company to each through and assert claims against its corporate parent since “the whole purpose of a corporation is to be a separate entity, a separate being from its owners, shielding the owners from liability if they didn’t have a part in wrongdoing.”

A couple years ago I was retained as an expert on corporate veil piercing for a case in Korea. As part of my work on that case, I researched the current state of corporate veil piercing and since that time I’ve probably stated something like the following to fellow lawyers at least a dozen times: “You know how difficult it is to pierce a corporate veil, well it’s even more difficult than you think. It seems that courts are now pretty much uniformly of the view that everyone now understands that Limited Liability companies and corporations protect the owners of those entities and corporate veil piercing is now nearly impossible unless there has been real fraud somewhere along the way.” Or to put it in non-legal terms, it ain’t gonna happen.

And yet again and again really smart in-house lawyers seem to ignore this when doing deals with big Chinese companies with U.S. subsidiaries. I cannot even count the times where such a lawyer has told me that they are not terribly worried about being able to pursue the big Chinese company on the other side of their deal because “we can always go after them here in the United States.” Wrong. Wrong. Wrong. Unless the U.S. subsidiary is a party to the contract or a guarantor on the contract, to go after that subsidiary you need to be able to pierce the corporate veil and that ain’t gonna happen. When I tell them this, they then talk about how they still can seize the Chinese companies ownership interest in that U.S. subsidiary as if that is no big deal. But the problem is that is a really big deal and any Chinese company worth its salt has structured its ownership of its U.S. subsidiary through various levels of Hong Kong and Cayman Island and Virgin Island companies. So yes, if you are willing to spend hundreds of thousands of dollars investigating the corporate trail and engaging in discovery on just this one issue, you might succeed. But really?

Our China lawyers see the result of this thinking with contracts between American and Chinese companies that call for disputes to be resolved in a U.S. court. At least once a month, one of our China attorneys will get a call or an email from a U.S. lawyer seeking our help in taking a U.S. judgment (usually a default judgment) to China to enforce. The thinking of the U.S. lawyer is that all we need do is go to a China court and ask it to convert the U.S. judgment into a Chinese judgment and then send out the Chinese equivalent of a sheriff to the Chinese company and start seizing its assets until it pays. As we have so often written, this will not work:

After we tell the American lawyers how difficult it is to collect on a U.S. judgment against a Chinese company (note that I say difficult and not impossible — it is possible to employ “other methods” to collect on such a judgment), they will sometimes explain that is okay because they can still go after the U.S. subsidiary of the Chinese company with which they have the contract. But as stated above, that is expensive and difficult and may or may not lead to a good result.

Aaron’s post focuses on how service of process on a foreign company’s U.S. subsidiary does not constitute service on the parent company and he uses Chrysler Motors as an example:

Take Chrysler, for example. When you sue Chrysler over a defective Jeep, you’re pretty solid in just serving the Michigan outfit. But if you allege liability on the part of the parent company, Fiat Chrysler Automobiles, N.V. (which we’ll just call FCA here– and I don’t mean the Fellowship of Christian Athletes), serving in Michigan ain’t gonna cut the mustard. You have to go abroad to get FCA on the hook. You can’t just hit Chrysler and assume that FCA is in the case, too.

The corporate veil doesn’t get pierced just because it hangs overseas.

Which means that if you want to serve Chrysler Automobiles N.V. you must do so in the Netherlands, where it is based. Again, it’s because the subsidiary is not the equivalent of the parent and vice-versa and as much as you may wish it otherwise, it ain’t. The same holds true for your China contract.

 

China intellectual property lawyersWhen our law firm started drafting manufacturing agreements on behalf of Western companies having their products made by Chinese manufacturers, we mostly dealt with simple items like socks, shoes, rubber duckies, etc. Those contracts were relatively fast and cheap and easy. The core of the contract was essentially something like this: “Your Chinese company will make rubber duckies out of these specific materials and with these additional specifications and you will deliver them to our facility in the United States or in Spain or in Australia within 45 days after we issue our purchase order.” Becuase these contracts were so routine and so simple, we virtually always always charged a flat fee for them.

Those days are mostly over for China, though these sorts of agreements are still relatively common for Vietnam, Cambodia, Thailand and Sri Lanka. These days the typical manufacturing agreement on which our China lawyers work is far more complicated because the products made in China are far more complicated. And with complicated products comes complicated intellectual property issues involving trade secrets, trademarks, copyrights and patents.

I called up an email this morning to review a China intellectual property issue on an existing matter. That first email led me to a couple more emails and today’s idea for a blog post. The below is a merger of three emails (further modified to remove any identifiers), which should be helpful to anyone looking to manufacture IP sensitive products in China, especially those that include software.

Oh, and for further incentive to get you to parse through the below email, go read China and The Internet of Things and How to Destroy Your Own Company to see what can happen if you fail to realize how critical intellectual property protections have become when having your products made in China.

 

We still need more clarification regarding the issue of ownership of the various technologies that will be going into your product.

Based on my review, there are four separate forms of technology embodied in this single product:

  1. The case or external shell.
  2. The internal mechanism: electrical/mechanical.
  3. The internal mechanism: firmware.
  4. The smartphone/computer application software.

Based on this, my questions are as follows:

1. For the external shell (Item 1):

a. Who will do the design? Who will prepare the actual CAD drawings for the mold? Who will fabricate the physical molds?

b. How and when will you pay for the molds to be made? Will you do this as part of a separate contract or will you fold this process into the manufacturing agreement?

c. Note that you will need to be clear that you own the shell design. If it will be done before/outside the manufacturing agreement, we will a clear document that provides for ownership and control. Note that if a third party does the mold (which is likely), there is a risk of the third party appropriating the design and selling it to someone else. However, for this specialized product, the risk is low.

2. For the application software (Item 4):

a. Who will create the application software? If it will be outsourced, you need to know. If it will be done in-house, will it be done by _________? You need to know.

b. Has a fee and timeline been determined for the software application? If so, what is it? If not, when will this be done?

c. What if the application software does not work? What if the application software does not have the “look and feel” you want? How will you work with the programmers to ensure all this is done how you want?

d. The fee, once determined, will be amortized against the purchase of the first 200 units. Does this mean the price of each of the first 200 units will be increased by 1/200 of the application software fee? What happens if you never buy more than 200 units? What happens if you end up buying only 100 units? You need to determine the fee to be sure this makes economic sense for you.

e. Will you own the application software copyright for the entire world? If so, we will need to specifically provide that the application software will be done as a “work for hire” and that your company will own the copyright on it. If you own the copyright, the Chinese side cannot sell the software to anyone else or use it for their own purposes. Will they agree to this? If the Chinese side is sophisticated, they will NOT provide you with the software copyright because they plan to reuse the core software for other projects. In fact, they may not even own the copyright to the core software. They may instead agree only to provide you with the rights to the “look and feel.”  Many U.S. buyers ignore these software issues, leading to many problems down the road. You may recall that the multi-billion dollar legal battle between Apple and Samsung is centered on these difficult “look and feel” issues.

3. For the electro-mechanical/firmware (Items 2 and 3).

It is not clear who will own and control this item because there is an internal contradiction in the description. On the one hand, the Chinese side says it will provide you with all data necessary for your company to patent and copyright items 2 and 3 in the U.S. (Note that firmware is protected by copyright, as are mask works and related). This means you would then own 100% of the rights to items 2 and 3 for the United States: permanently and forever, to the exclusion of everyone, including _________. This means you would not even be required to purchase the product from ________ because you could have it manufactured by anyone in any location where a conflicting patent and copyright has not been registered. It also means even if you do not secure a patent or copyright on this, you still have an exclusive and perpetual license to the technology for the U.S. This perpetual license would have essentially the same effect as a patent or copyright registration with respect to your relation to __________ and its attempts to license to any third parties in the future. The point here is that a patent is not revokable; once you have it, it is yours for the term. On the other hand, the Chinese side wants to have the right to allow other U.S. entities to make use of the technology to sell competing products in the United States if your company does not meet certain sales quotas. Under this approach, the Chinese side is providing you with essentially a limited license with these terms: a) the product must be purchased from _________ and no one else, b) your sales territory is limited to the United Sates, and c) your license terminates if you fail to meet the sales quota. This has in fact become the normal approach for sophisticated Chinese companies making products like yours.

The issue though is that these two approaches are contradictory. Only one can stand. So which one is it? As I have noted, the second option (limited license) is most common. However, that means your company’s product development would be placed on a very weak footing because your entire product line could be terminated if you fail to meet the sales quotas. This termination could come either from the license becoming non-exclusive, (allowing the Chinese side to license to and manufacture for other U.S. companies) or from the Chinese side terminating the agreement.

This issue goes to the core of your agreement and so it is crucial that we get clear on on this for the agreement. As noted, most Chinese manufacturers/designers will take the limited license approach instead of terminating the agreement. If this is their approach here, their offer to provide you information for a patent application is not consistent because a limited license and absolute ownership rights are contradictory.

4. There is an additional issue related to the rights of non-U.S. entities to sell into the U.S. market. This can only be resolved after we get answers to the questions above.

5. There is an additional issue concerning what to do if _________ is unable or unwilling to manufacture your product at an acceptable price, at acceptable quantities, with acceptable delivery dates and at an acceptable level of quality. If ________ owns the core technology and is merely providing you with a limited license you could find yourself “stuck” with bad pricing, bad quantities, bad delivery times and/or bad quality products. The normal remedy would be for us to state that if any of the above problems occur, you have the right to have your product made by some other manufacturer and that ________ will provide you with a license to the technology that will allow this. Though this is the normal remedy, many Chinese manufacturers strongly resist this, putting you in a difficult position. You have indicated that ____________ will be required to accept purchase orders that meet the price agreement. You have also provided for penalties for late delivery and for defect issues. Though this is not ideal, it may be the best you can do in your current bargaining position. So the key issue is whether you are required to purchase from __________ or not. If you are required to purchase exclusively from ___________, you will need to face the fact that you are in a very weak bargaining position on many critical business issues and ____________ can fairly easily make life difficult for you by forcing you to fail to meet the sales quotas that will then enable it to start working with U.S. company that competes with you.

Please advise on the above. After we get clear on these various issues, I can begin drafting the agreement. I realize these issues are difficult, but it it is best to take a clear position from the start. Please let me know if you have any questions or if you need any additional explanations.

China employer social insuranceChinese law mandates employers provide their employees certain mandatory benefits, including social insurance. China has five types of social insurance: pension, medical, unemployment, maternity and work-related injury insurance. The specific types of social insurance employers must provide and their contribution formulas vary depending on the employer’s location. Many foreign employers in China do not realize that failing to make full payments on required social insurance gives their employees the legal right to unilaterally terminate the employment agreement without providing any prior notice and then turn around and sue the employer for damages.

Just to make things more complicated for China’s employers, China has several forms of social insurance violations. You obviously violate the law if you don’t pay any social insurance at all, but the violations by foreign employers in China I most commonly see are more subtle and complicated than that. We see violations when employers fail to pay social insurance for the entire term of employment. This violation often happens when the employer thinks it need not pay social insurance during an employee’s probation period. We also see violations involving employers failing to pay for all five types of social insurance. And with rising wages in China, we have lately been seeing a rash of employer problems arising from paying social insurance based on a lower salary than is actually being paid, either because the employer failed to update the salary amount or because it intentionally reported a lower salary so as to reduce its employer contribution. These are the sorts of things we constantly look out for in our HR audits.

Employees may consent to the employer claiming a lower salary but that is irrelevant once caught or even once reported by the employee who consented. In a fairly recent case out of Jiangsu Province, the court reinstated the employer’s obligation to pay for all required types of social insurances at full rates the entire time. I am simplifying the facts for this post, but basically the employee’s monthly salary was higher than 7000 RMB, and the employer only contributed social insurance as though the salary had been 2200 RMB. The employee terminated the employment relationship and sued the employer for severance, arguing that he had been forced to leave his job because the employer failed to pay mandatory social insurance. The case went from labor arbitration, to trial, to appeal and then the employer petitioned for re-consideration by the Jiangsu Province High People’s Court. The employer lost every single step of the way (which really should have been no surprise to any experienced China employment lawyer, sorry!) and was required — among other things — to pay the employee for statutory severance.

Each step of the litigation process, the employer made the following three (futile) arguments. One, the employee never objected to the arrangement of the employer misstating the employee’s salary and therefore underpaid the employee’s social insurance. Two, because the employee never voiced any objection to the social insurance payment arrangement, the parties essentially agreed on a different base for social insurance payments. Three, the employer’s failure to contribute the full amount of social insurance was not the same thing as failing to make any contributions at all, so the employee was not entitled to statutory severance. The Jiangsu Province High People’s Court rejected all arguments and explicitly (and rightly) stated that the laws on social insurance are clear and the employer’s failure to contribute the full amounts based on the employee’s actual wages entitled the employee to terminate the employment contract and receive statutory severance pay from his employer.

To reiterate what is becoming a fairly regular theme of my China employment law posts, most China employment laws cannot be contracted away and an employee’s written consent does not change that. An employee’s written acknowledgement that he or she specifically asked for a particular employment arrangement also does not change that.

As a foreign company doing business in China, you are under a microscope and you will be treated differently than domestic Chinese companies. This means that you are both more likely to get caught on employer violations and more likely to get called out and treated harshly when caught. In our experience, if the labor authorities are not pursuing you for non-compliance, your employees almost certainly will either before or certainly after they leave. This brings me to another point. If your employee tells you she is leaving her employment and alleges she has been forced to quit because of employer wrongdoing (or even just provides inconsistent stories about why she is leaving), you should immediately work on resolving those problems (which is exactly what they are) before she takes you to court.

 

 

Doing business in ChinaOn March 30, China Law Blog’s own Dan Harris will be putting on a webinar on the legal aspects of doing business in China, with a focus on how to structure your Chinese operations and deals so as to protect your IP. This webinar is being put on by CommercialLawWebAdvisor, which describes it as follows:

Companies often cannot afford not to do business in China. Whether producing goods there or selling to the Chinese market, companies that engage in business with Chinese partners need up-to-date legal advice on how to protect their technology and other intellectual property (IP) interests from being counterfeited, pirated, or otherwise misappropriated. As IP theft is one of the top issues facing businesses operating in China, there are substantial risks companies must identify and address proactively to protect their valuable IP assets. Deals made in China can threaten IP rights not just in China, but in markets around the world. Understanding the Chinese IP landscape and how to manage the pertinent issues can go a long way to safeguarding your client’s valuable IP interests.

Please join Dan Harris as he explores the nuts and bolts of constructing a good business deal with a Chinese partner, what your agreements should include, and how to manage the Chinese IP rights framework to minimize your client’s IP-related risks.

WHAT YOU WILL LEARN
This webinar will cover:

  • How to choose a good Chinese partner
  • Identifying the IP assets that need protection
  • How to structure your deal
  • Drafting your deal papers
  • Drafting China employee contracts to protect your IP
  • IP registrations: What you should know about trademarks, patents, copyrights, and licensing agreements

YOUR CONFERENCE LEADER
Your conference leader for “Doing Business in China: Structuring Your Deal and Protecting Intellectual Property” is Dan Harris. Dan is an attorney with Harris Bricken, LLP, in Seattle. He is internationally regarded as a leading authority on legal matters related to doing business in China and in other emerging economies in Asia. Forbes Magazine, Business Week, Fortune Magazine, BBC News, The Wall Street Journal, The Washington Post, The Economist, CNBC, The New York Times, and many other major media players have looked to him for his perspective on international law issues.

Dan writes and speaks extensively on Chinese law with a focus on protecting foreign businesses and his China Law Blog is regarded as one of the best law blogs on the web today. The ABA Journal recently named the China Law Blog to its Blawg Hall of Fame (a designation given to the top 20 law blogs of all time).

This session is recommended for corporate and in-house counsel and really for any attorney who advises companies or organizations on China and on China IP issues. It also is good for intellectual property attorneys looking to learn more about China IP law and what makes it so different from common law countries.. Find out more about costs and registration here and for a $35 discount use promo code cw17bc.

We hope to “see” you there.