China attorneys One of our China lawyers got a weird call a few weeks from a somewhat distraught clothing manufacturer who had just learned that products his company was having made in China may in fact have been made in North Korea. This person wanted to know whether if that were the case whether he might go to jail. When we told him we didn’t know whether it would be illegal or not and that much would likely depend on how much his company knew about the North Korea connection and when, he very quickly lost his ardor for hiring us.

I thought of that call today while reading an article entitled, North Korea factories humming with ‘Made in China’ clothes, traders say. The article essentially says that some clothes that bear a “Made in China” label are actually being made in North Korea. And some are being made in China by North Korean “guest” workers. The degree of culpability for this sort of thing usually ranges roughly along the following spectrum:

  • Those who know and approve of their products being made in North Korea yet labelled “Made in China.” These companies no doubt like the cost savings.
  • Those who don’t want to know where their products are made and make zero effort to prohibit their products being made in North Korea and make zero effort to monitor where their products are being made.. These companies no doubt also like the cost savings and courts tend to categorize them as “having known or should have known.”
  • Those who are actually making a reasonable effort to make sure the products they are sourcing from China are not being made in North Korea.

Now without even discussing whether having your products made in North Korea, funding (albeit indirectly North Korea), and receiving products made in North Korea is legal or not — and this will vary by country — how do you want to be viewed if you are ever before a judge or a jury in your home country? Do you want to be seen as the person/company that tried to stop your products from being made in North Korea, the company that affirmatively didn’t care or the company that encouraged? Now before you answer that, ask any lawyer (no matter what the law is) which category of client he or she would rather defend. The answer to that is obvious. When facing a judge or a jury, the company/person that looks the best is the one most likely to prevail.

Just imagine if opposing counsel gets into evidence some of the things from this article, including how “In North Korea, factory workers can’t just go to the toilet whenever they feel like, otherwise they think it slows down the whole assembly line.” Or that the workers get to keep only ⅓ of their wages, which are only half those in China to begin with, and yet work from 7:30 a.m. until 10 p.m., or 14.5 hours. If facing a jury with those facts doesn’t scare you, I do not know what will.

So when it comes to North Korea how can you be good to look good? It’s like just about everything else with China and with manufacturing: you put how you want your Chinese counter-party to act in your contract (and if you want that contract to actually work, you do these things as well) and you monitor as best you can whether your Chinese counter-party is actually abiding by the terms in your contract.

Simple yet not so simple. But really important.

Your thoughts?

 

China lawyersOne of the joys of blogging is finding gems in unlikely places (pun intended). The gem is a post entitled Jewels Plating Problems: Can You Trust Chinese Factories? I say unlikely because neither (nor I would bet, most of our readers) have much interest in jewels plating problems. Heck, I am not even sure what those are and I wonder whether the writer (who I presume to be French) mistranslated. But I looked at the post because it is a truly excellent blog and the post is actually highly relevant for anyone doing any sort of manufacturing in China. The blog is written by a Shenzhen-based factory auditing company with whom our China lawyers have worked on many China manufacturing matters, and rest assured — for jewels plating or whatever — these people know whereof they speak when it comes to China manufacturing. And this post is no exception.

The post ostensibly deals with how relatively inexpensive jewels (jewelry?) made of brass and plated with gold so often have quality problems. The post then does a great job digging into why this just keeps happening in this industry. This is an industry our China lawyers know well because much of it is based in Qingdao or thereabouts and our firm has long-standing connections to that city. This is also an industry with low profit margins (for just about everybody) and — as President Trump might stupidly put it — a lot of bad hombres.

The post starts out asking “what is happening in this industry? Are they [the Chinese manufacturers] cheating the buyers, or are they simply careless?” It then gives the following three part explanation:

  • Profit maximization with a “calculated risk” approach — what is sometimes referred to as “quality fade.”
  • Reliance on so-called experience — not on facts and objective data.
  • Buyers who don’t define their quality expectations clearly enough.

To which I say, yup.

The post then analyzes/explains each of these three things.

1. Profit maximization with a “calculated risk” approach. Once a Chinese supplier ships its goods, the shipment has usually been approved and paid for and the transaction is fully completed. There are a few reasons for that:

  • High logistics costs
  • The process to return jewels is a nightmare
  • Customs clearance (cost and time) at both the supplier and buyer sides

The above means that China manufacturers try to ship products “as cheap to produce as possible, and yet are likely to be accepted by the buyer. For example, if a buyer is asking for 1um gold plating, the jewels might only have a gold layer of 0.5um.”

2. Reliance on so-called experience — not on facts or objective experiments. According to the post, most buyers are surprised by this. “Chinese factories in general barely have an R&D team. Their expertise is based entirely on their intuition (which they call their “experience”), and unfortunately it can’t be fully trusted.”

Again, I can only assent.

When buyers bring a new case to their Chinese supplier, the supplier tries to remember similar cases. This might work in a factory that has been in business for many years with a stable staff and good problem solving abilities, but it doesn’t work in a small workshop started recently.

3. Buyers who don’t define their quality expectations clearly enough.

The post does not free buyers from at least partial blame. I personally see the foreign buyer as at least partially at fault most of the time. Not saying the Chinese manufacturer is not also at fault, because it usually is, but most of the time had the foreign buyer taken action before the problem arose, there would have been no problem. I wrote extensively on this in China Factory Problems: Always YOUR Fault?

The title is somewhat of a stab at humor. It stems from my blaming most (but certainly not all) China factory problems on the foreign buyer. We have written countless times of what is required to secure good product from Chinese factories:

How To Get Good Product From China; Specificity is THE Key To Your OEM Agreement.

China OEM Agreements. Ten Things To Consider

China OEM Agreements. Yet Another Reason To Have One

China Supply Agreements. Why The “Perfect” OEM Agreement Should Cost Less

OEM Agreements With Your China Supplier. Not Just For The Big Boys

China OEM Agreements. Why Ours Are In Chinese. Flat Out

The Five Steps To Successfully Buying Product From China.]

China Manufacturing Agreements. Make Liquidated Damages Your Friend.

We have also written how our China lawyers constantly get calls or emails from American and European companies that have received bad product from their Chinese factory suppliers and how there is nothing we can do for them. We wrote about this just last week in How To Get Bad Product From China With No Legal Recourse. To a certain extent, we like being able to blame the victim in these situations because that way we as lawyers can comfortably sit back and tell ourselves that had they only contacted us BEFORE they started having problems, we could have prevented all of their problems.

But what about where the Chinese company just up and suddenly shuts down. How can the American or European buyer be blamed for that? Well guess what, they can and in Doing Business In China Safely. The Due Diligence Basics, I explain the following situations where blaming the victim is really pretty easy.

This post rightly blames buyers for not explaining their quality and manufacturing standards clearly enough to their Chinese manufacturers:

In some cases, the buyer asked for the plating to last for at least 6 months or 1 year. That’s better than nothing. But some factories see this requirement, confirm the need for 1um (or sometimes for 0.5um) gold plating, offer a competitive price, and are likely the get the customer’s business.

For a case of greenish effect on the skin, I called and discussed with tens of Chinese factories. The result was surprising. A few (yes only a few) provided real expert feedback. Most of them provided different requirements (some of them scientifically ridiculous) and said “do not worry, we will provide great quality if your client buys from us”.

Plating, be it on jewels or other products, is an expertise area that most factories haven’t mastered. If plating is critical on your product, you might have to acquire the knowledge to guide (or force) your suppliers to be compliant with clear quality standards.

The post then goes on to explain how to be clear with your plating standards.

What this post does not do though is explain the various ways you as a buyer of manufactured goods from China can avoid quality problems. For that, I suggest you read Five Keys To Getting Good Quality Products From China. In that post, I assure our readers that if they consistently do the following five things, they will get good quality products from China:

  1. Use a Good Company.  Sounds rather basic, but we constantly see this rule violated. If you do nothing else that we suggest in this post, do this one thing as it matters as much as all the other things put together. For how to learn more about “your” China company, check out Basic China Due Diligence. Is This Chinese Company Legitimate?
  2. Use a Good Manufacturing Agreement. Good contracts ensure that your Chinese company knows what is required of it and what will happen if it fails to provide it. For what constitutes a good Manufacturing Agreements herehere  here, and here. Most China contracts we see are completely worthless, with a good chunk of those being even worse than having no contract at all. See Why Your NDA is WORSE Than Nothing for China and Is Your China Contract Worthless?
  3. Use Detailed Documents. Chinese factories tend to do exactly what you tell them to do. This means that what you tell them to do needs to be clearly conveyed and that means your instructions and specifications should be detailed and in. Be specific.
  4. Visit the Factory. Either your own people or a third party QC company should pay regular visits to your factory. Doing this allows you to make sure it understands what you want and lets them know that you are serious about making sure you get it.
  5. Inspect. Perform regular product inspections appropriate to the product you are having made.
Do the above and your odds of getting good product go way up. Don’t do the above and they go way down.Your thoughts?

China NDAAmerican and European companies constantly come to one of the China lawyers at my firm seeking to “shore up” their China IP protections. These are mostly companies that have been doing business in China or with China for months or years and have now decided they are doing well enough financially there to start paying to protect what they have. Let me start out by being clear: it is nearly always better to be late than never when it comes to protecting your IP, both regarding China and otherwise. But let me also be clear that it is also nearly always better to take action to protect your IP before you do anything with China at all.

Far too many of the foreign companies that come to my law firm seeking to “shore up” their China IP protections actually have no China IP protections at all in place. But they wrongly believe otherwise.

Many of these companies do not realize that unless they register their brand name as a trademark in China they are at real risk of losing their right to use their own brand name in China, even if just on their own product or packaging made in China for export elsewhere. See China: Do Just ONE Thing: Register Your Trademarks AND Your Design Patents, Part 1. Some of these companies think they’ve already protected their brand name from trademark “theft” in China, but our own trademark search reveals they have not. See China Trademarks. Register Them In China Not Madrid and China Trademark Registration: Keep it Real.

But by far the most common misbelief regarding China IP protection we encounter is the foreign company that believes its United States style NDA protects their IP in China when it most emphatically does not. See Why Your NDA Does Not Work For China. When I tell them that these NDAs do not provide any protection unless the China company that signed it has assets in the United States their response is almost invariably something along the lines of, “well it is at least better than our having nothing. My response to that is silence and then I say something positive and forward thinking, but ultimately noncommittal like, “well, fortunately, we can now start taking substantive action to protect your IP from China.”

But what I am thinking is, “wrong, your NDA is actually WORSE than nothing.” And here is why.

  1. Your China counterpart knows the NDA it signed is worthless and your using that NDA tells it that neither you nor anybody working for you (within or outside your company) has even the most basic knowledge of what it takes to protect IP in China. In other words, you are ripe for the picking.
  2. Your NDA is pretty much a free pass for your China counterpart to steal your IP with impunity and this is true for multiple reasons, though one reason usually stands out. Your NDA no doubt says all disputes will be resolved in an American court under United States law. Now let’s suppose your China counterpart steals your IP and you want to sue. You now must sue in a United States court and that means you have almost certainly cut off any possibility of recovering anything as against your China counterpart. For why this is the case, check out Enforcing Foreign Judgments In China — Let’s Sue TwiceChinese Companies Can Say, “So Sue MeWhy Suing Chinese Companies In The US Is Usually A Waste Of Time, and Enforcing US Judgments in China. Not Yet.
  3. If you had no NDA you could at least threaten to sue or actually sue your China counterpart in China for statutory trade secret or other potential IP violations. But your NDA agreement actually precludes that.

Sorry.

If you want to protect your IP from China you need an appropriate China NNN Agreement. It’s that simple.

China insurance and indemnificationWebster’s Dictionary defines indemnification as “to make compensation for incurred hurt, loss, or damage” and our clients often request indemnity to protect against a product that injures people or infringes on some third party’s intellectual property right. Seeking such indemnification makes complete sense because the last thing you want when you buy $250,000 of some product is to find your own company on the wrong end of a massive lawsuit for personal injuries or patent infringement. If you are going to have a product manufactured for you in the United States or in the European Union, you commonly include one or more indemnification provisions. In addition, it also usually makes sense to require your manufacturer have enough insurance to be able to pay you on any indemnification claim.

Less so when buying products from China.

The issue of products liability insurance is significant for China, yet in our standard manufacturing agreements with Chinese companies we typically do do not reference insurance. The reason for this is because products liability insurance that would cover U.S. or European based products liability/government recall claims is generally not available in China. Most Chinese factories carry no insurance at all for this type of claim. This lack of insurance is a reason for the “China price.” For entities that want to be covered by insurance for U.S. or European based products liability claims, the best solution is usually to purchase such insurance from a U.S. or a European insurer. The cost of such insurance then illustrates why the China price is often not as low as it seems.

Some of our clients insist on including a standard U.S. or European style insurance provision in their manufacturing contracts with Chinese factories. This usually elicits one of the following three responses from the Chinese manufacturer:

  1. The honest Chinese factories usually refuse to agree to this requirement/provision because they know they probably will not be able to secure this insurance.
  2. Some Chinese factories agree to sign but then also state that they will raise the price of their product(s) to account for the added cost of the insurance. In this case, what they usually mean is that they will purchase the insurance from a U.S. or European insurance company and they will pass on the price of the premium to the U.S. or European buyer.
  3. Some factories will sign but then not obtain the insurance.

We have seen Chinese companies provide fake policies to try to trick Western companies into believing they have insurance. If it is going to cost you the same amount to have your Chinese manufacturer secure sufficient insurance coverage to protect you, but you run the added risk of being tricked about the existence of the coverage, you really do need to ask whether this request even makes sense.

And here’s another thing to consider if you think you are going to be protected by your indemnification provision and/or your Chinese counterpart having secured insurance for you. With China cracking down so hard on hard capital leaving the country (See Getting Money Out of China, Part 6 and the five posts that proceeded that), there is a good chance that even if there is someone in China wants to pay you in the United States or in Europe they will be unable to do so.

In a more general way, one of the risks you will face in getting your products from Chinese manufacturers is that Chinese tend to be either underinsured or not insured at all. This imposes significant risks most U.S and European buyers do not take into account. For example, say you pay a 30% deposit/prepayment for your products and then the factory burns down, and your work in progress is lost. In this case, it would be very rare in China for the factory to have insurance that would cover you for this loss. Say you make the mistake of purchasing your product on FOB terms. In this case, your shipping insurance does not cover the product until after it is loaded on the ship. Say the product is lost in a vehicle accident on the way to the port or in an explosion at the port. Again, it is unlikely the Chinese factory will have insurance covering the situation and once again your deposit is lost. In the U.S. or in Europe, the odds are great these sorts of things would be covered by an appropriate insurance provision, naming your company as an additional insured, but this type of insurance is generally not available in China. So the only way to cover the risk is to purchase your own insurance, which again raises the actual cost of purchasing from China. Most smaller companies either do not understand the risks they take or they take the risk intentionally. In either case, they are underestimating the true cost of purchasing products from China.

As you can see, these various insurance/indemnification issue are quite difficult for China and there are no easy answers.

What do you do to minimize these China risks?

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.

One of the most common questions we will get asked will be something like the following:

I paid my supplier in China X dollars for Y product and the quality is so bad I cannot even use it. Do I have a good case against them and what would you charge us to pursue it.

My response is usually something like the following:

Do you have a written contract with this Chinese supplier?

Is it in Chinese?

Is chopped/sealed by your Chinese manufacturer?

Does it provide for disputes to be resolved in China?

Does it clearly specify what you will be buying and its quality requirements?

Does it clearly provides that any failure to satisfy the product requirements will lead to you being entitled to specific monetary damages against the Chinese company?

If your existing contract provides for all of the above (or at least the first four), we can help and we’d be happy to do so. If you do not have at least the first four above, our chances of being able to help you are not so good and it probably will not make sense for you to hire us.

If you want to protect yourself in the future, I would urge you to use an appropriate Manufacturing Agreement (a/k/a OEM agreement or product supply agreement) the next time around. You can find out more about our Manufacturing Agreements hereherehere, and here.

I should also note that we have been dealing with a massive increase in companies that are losing their ability to have their products manufactured in China entirely because their suppliers there are registering their trade names and then preventing their products from leaving China. If you put your company or your brand name on your products (or on their packaging) you should immediately register your brand/product name and logo as a trademark in China, if you have not already done so. As we discuss here, this is true even if you will not be selling your product in China. I mention this because when foreign companies start having problems with their Chinese manufacturers (like what you are having) the Chinese manufacturer often will go off and register the foreign companies brand names as their own trademarks in China so as to gain leverage against the foreign company. Therefore — and I know this will probably surprise you — the one thing I would urge you to do immediately is to make sure your brand names are registered as trademarks in China and if they are not, to do so immediately.

 I hope the above proves helpful to you. If you have any additional questions, please don’t hesitate.

What are you seeing out there?

China manufacturing trademarkLast year, in Your China Factory as your Toughest Competitor, I wrote about how our China lawyers have “gotten more calls in the last year from companies whose China factories are now directly competing with them than in probably the three years before that combined.” I went on to explain how “Chinese factories are more confident now than they have ever been about going out into the world with their own products, and more willing to toss their foreign customers to the curb early. Amazon and Alibaba do not help matters as we are getting roughly a call a week from someone whose product is being sold on Amazon and/or Alibaba by their Chinese factory.”

The other day I secured permission to write about a sourcing company that contacted us regarding this problem for one of its clients that makes IoT (Internet of Things) products in China. The below is our email correspondence (stripped of any possible identifiers):

IoT Product Sourcing Company: I’ve got an interesting story for you which could potentially mean some China contract work for your team. One of our best clients currently has a written contract with its China manufacturer, but it was written for them by their regular attorney who does not know China and it is badly written. We told our client this going in, however it’s tricky telling our client that their contract is not good, or even that their colleagues have no idea what they are doing. I’m sure you can relate but it’s especially tough for us because we are not lawyers and we do not want our clients ever to think that we are providing them with any legal advice, but like I said, we figured from the contract that they would eventually have problems and now they are.

We have a factory producing a products for us. Various kinds of fairly high end IoT industrial products. Quite profitable too. The contract in place details minimum order quantities annually and clauses related to exclusivity for Spain, France and Italy. During the past 16 months our client has failed to meet the minimum order requirements so its exclusivity is now uncertain. The main reason for their not meeting the minimum order requirements is problems the Chinese factory had with packing the products in a way that protects them during shipment and also problems with the products themselves. These issues have been sorted out now and my client is ready to move ahead with large orders every month. There are also molds involved that are worth well over a million RMB in total.

My client received an email from the factory last week saying they will be attending the ____________ trade fair in __________ and they want my client to send a sales person to represent them. Just to be clear, the Chinese factory wants to show my client’s products in Europe, with a focus on selling it in Spain, France and Italy! This email was quite amusing as they also asked my client for some information regarding how to install the products and requested my client send them a technical person to give more details about the whole system. They offered even to pay for this technical help. My client is a concerned but I find it amusing because the Chinese company has no idea what testing or standards are required in Europe as they manufacture almost exclusively domestic products. It would be a bit like a factory in China exhibiting in the US and telling Home Depot (their client) that they were going to help Home Depot sell its own products. But at the same time, I also know that this Chinese company is probably just one technical and marketing person away from being able to sell my clients products all over the world for 30 to 40% less.

I am curious on your thoughts and I was thinking of the below, but would be open to more:

1.  NNN contract. It may be too late for this as I am not sure the Chinese supplier would be keen to sign a new contract at this point. From their point of view, they already have a great contract.

2.  Trademark in China. Just reading a bit on your site it seems to me my client should be doing this, or really should already have done this.

3.  Have you heard of a trade show barring a supplier from attending because they are selling essentially stolen products?

Please let me know what you think when you have some time.

My response was as follows:

My first advice to you would be to stay completely away from ALL of the legal issues and let your client deal with all of these issues itself. Your client should not expect you to give it legal advice and your doing so just increases the odds of your being blamed when things go wrong and of your being sued and losing on the same grounds.

I would need to know more to be able to provide all options but I can say that separate and apart from what has been transpiring between your client and its factory, your client has indeed made a big mistake by not having already registered its trademark(s) in China. That is the one thing above all else that anyone manufacturing in China MUST must do. See Manufacturing in China: Trademark Registration Should be the First Thing You Do.

As for the issue regarding the factory, a trademark will shut down rival sales as the factory could still sell the same products under a different name, but at least it can stop it from selling your client’s products under your client’s name! We also should talk more as patents in China and elsewhere might be possible, and if they are, they might help. [It turned out the company was too late to secure any patents]. You can try to get the fairs to block this China factory, but I do not see how that will happen because near as I can tell, the China factory is acting legally because it is not violating any contract or any registration.

I cannot recommend doing anything with the factory without getting the whole story because I am scared to death of what could happen here. One part of me says your client should tell its Chinese factory to “sign a new (good) contract now or we walk,” but the other part of me says that would be crazy because this will likely cause the Chinese factory to say, “great, and we keep the molds because they belong to us” and we keep making your products and now we add your brand name to them them because there is nothing to stop us from doing so. And what will your client then do? By the time it has new molds made and starts even trying to fight back, it will likely have lost all or nearly all market share to its factory.  I say this because I presume that the contract your client has with its China factory does not make clear that the molds belong to your client nor provide any real incentives to prevent the factory from hanging on to them. But really, the bottom line is that unless your client wants to retain us so we can get all the facts and figure out step by step what it can do there is really nothing we can do but speculate. A

The email address for the sourcing company no longer works and so I have no update on what eventually happened, but I very much doubt any good result.

What should you do to prevent the above? The following three things are key:

  1. Choose your China manufacturer wisely. Due diligence is the answer to this.
  2. Make your China manufacturer sign a contract making clear that you own the molds, that you own the products and that it will not compete with you.
  3. Register your trademarks in China and with China Customs, register your patents in China and register both of these wherever you sell your products.

Grey Market Goods and ChinaIn this projected 4-part series we’ll take a closer look at grey market goods and China. In part 1, we discussed what grey market goods are and why manufacturers get so worked up about them. Today, in part 2, we’ll look at how grey market goods are regulated in China. In part 3, we’ll look at how grey market goods are regulated in the United States. And in part 4, we’ll look at grey market goods and Chinese factories, and what foreign companies can do to protect themselves.

Part 2: How Are Grey Market Goods Regulated in China?

One of the minor mysteries of modern China is how every mall has so many luxury-brand stores that seem never to have anyone shopping inside. I’ve read numerous explanations for this disparity, none of them entirely satisfactory: the shops are loss leaders in an effort to build brand loyalty in China; the shops are highly subsidized by mall owners to bring in other tenants and/or to give them face; all of the sales are made after hours to Party officials’ relatives and mistresses; people just aren’t paying attention at the right time.

But one answer for the empty stores, surely, is the enormous size of China’s grey market for luxury goods. In 2015, Chinese citizens spent $22.5 billion on luxury goods purchased in China – and more than twice that amount abroad.

As noted in part 1, grey market goods exist because there’s a market for them, and that market exists because grey market goods are either cheaper or have better availability. But in China there’s a third driver of the grey market: quality. It’s ironic because in the US, grey market goods have a strong whiff of caveat emptor; if you buy a product outside the normal channels you accept the risk that it might be lower quality. But in China, the calculus is flipped: because counterfeiting is so rampant, the chance of buying a fake is considered to be much lower if the goods come from overseas.

Historically, a significant proportion of grey market luxury goods in China have come via daigou, personal shoppers (usually young Chinese women) who live or travel overseas and purchase luxury goods for well-heeled clients in China. I’ve seen this in action: at Seattle Premium Outlets’ Burberry Store, you sometimes have to wait in line just to get in the store, only to be ignored when it becomes clear you’re not there to drop twenty thousand bucks.

Other grey market goods in China are purchased directly by consumers, either while traveling overseas, or from foreign reseller sites like eBay. Grey market goods can also be found on Chinese e-commerce sites like Taobao and 1688.com; these goods are usually purchased “on spec” overseas and then resold in China. (The daigou as impersonal shopper.) Baby formula and iPhones have, at various times, been extremely popular grey market goods in China.

Grey market goods are legal in China, or at least not an infringement of the brand owner’s IP rights. Indeed, Shanghai’s Free Trade Zone has a car dealership that specializes in grey market automobiles.

But many grey market goods in China run afoul of the law in another way: customs fraud. When the goods are brought into China, they are not declared at all or are declared at lower values. Defrauding Chinese customs is an essential part of many a daigou’s profit margin, because China has historically imposed significant duties on a range of luxury imports.

China has attempted to crack down on illegal grey market importation through a number of means, including (1) higher taxes on goods brought in by travelers as part of their luggage, (2) lower taxes on goods imported through legitimate channels; and (3) increased penalties for those caught falsifying customs declarations.

The effectiveness of these measures is a bit hard to gauge: some reports say the measures are eliminating large-scale daigous; others suggest that the enforcement is both haphazard and overbroad, and that when Chinese people attempt to order directly from overseas retailers, the packages are frequently rejected at the border, with the result being that people are even more reliant on daigous to get the products they want.

On a certain level, foreign brand owners might not be that concerned about grey market imports in China – Christian Louboutin gets paid whether a pair of pumps is bought in Shanghai or in Houston and then taken to Shanghai and resold. But they should be concerned, for several reasons. First, they want to be seen as cooperating with the Chinese government on tax and customs issues. Second, having to deal with so many purchases by Chinese travelers overseas is a drain on resources (staffing, marketing, logistics) and distorts the worldwide revenue stream. Third, sometimes the prices in China, even accounting for taxes and tariffs, are higher than they are abroad — although a number of brands have normalized prices in China in an attempt to dissuade gray market sales. Fourth, the daigou phenomenon increases the amount of intermediation between brands and their consumers, which is exactly the opposite of what companies want. How can you market to customers when you don’t know who they are? And how can you control your brand identity when you are not the seller?

In part 3 of this series, we’ll look at how the United States regulates grey market goods.

Grey Market GoodsIn this projected 4-part series we’ll take a closer look at grey market goods and China. In part 1, we’ll consider what grey market goods are and why manufacturers get so worked up about them. In part 2, we’ll look at how grey market goods are regulated in China. In part 3 we’ll look at how grey market goods are regulated in the United States. And in part 4, we’ll look at grey market goods and Chinese factories, and what foreign companies can do to protect themselves.

Part 1: What are grey market goods, and why do they matter?

Grey market goods are authentic goods sold by unauthorized means. Unauthorized does not necessarily mean illegal; it simply means the goods are coming from someone other than (1) the original manufacturer or (2) a third party to whom the manufacturer has granted permission to resell the goods.

E-commerce has made all manner of grey market goods readily available. When I purchase Gillette razor blades on Amazon for delivery in the United States, the cheapest sellers are all offering grey market blades packaged for sale overseas (typically, Asia, Eastern Europe or South America). Although it’s unclear if these blades are exactly the same as what I would buy at a drugstore in the U.S., the price difference is significant enough that I’m willing to take the chance. And that’s just one example. Any product that has a significant difference in price or availability across different countries is likely to be sold on the grey market. And the flow of goods could go in any direction; it just depends on price and the demand. As China’s consumer class has grown in strength, so has the market for grey market goods. Products as disparate as Apple’s iPhone and Pfizer’s Viagra did significant business in China as grey market goods before they were officially available there.

Grey market goods are hardly a creation of the Internet, though.

A Vancouver, BC man named Michael Hallatt grew tired of waiting for Trader Joe’s to come to Canada, and since 2012 he has operated a store in Vancouver called Pirate Joe’s that stocks nothing but goods bought at Trader Joe’s stores in Washington State. All of the goods are purchased at retail prices in Washington and then marked up for sale in Canada. Trader Joe’s has been trying to shut Hallatt down for years, and has sued him for trademark infringement, unfair competition, false designation of origin, and false advertising.

Two weeks ago Pirate Joe’s announced it was closing its doors, which would have made the lawsuit moot, but at the end of last week Hallatt reversed course and announced on the PJ’s website that he was back in business. What makes Pirate Joe’s story interesting for IP attorneys is how it calls into question the limits of grey market sales. Hallatt certainly seems to enjoy tweaking Trader Joe’s and skirting the edge of the doctrine, but as the Freakonomics blog pointed out in 2013, reselling Trader Joe’s goods is no different than reselling goods on eBay or at a yard sale. The case is still pending.

In another well-known story, Costco purchased large quantities of Omega Seamaster watches from an authorized reseller in Europe, then resold them in the U.S. as grey market goods. Because the prices in Europe were so much cheaper than the retail prices in the U.S., Costco was able to add its usual markup and still price the watches at a substantial discount. Omega sued, but after a protracted battle, Costco prevailed in 2015.

It may be self-evident that the reason grey market goods exist is because there’s a market for them: grey market goods are either cheaper than the goods available through standard channels (e.g., the Omega watches at Costco and the Gillette razor blades on Amazon) or they are simply unavailable through standard channels (e.g., the goods at Pirate Joe’s). A reasonable argument can be made that grey market goods are in fact good for many manufacturers, because they increase brand recognition and product loyalty. And profits! All of these products have been sold by the manufacturer at a price (if not a use) they deemed acceptable.

Nonetheless, grey market goods are often decried by original manufacturers for reasons including the following:

  1. Grey market goods are often difficult to distinguish from counterfeit goods, which harms the reputation of the brand and the manufacturer.
  2. Grey market goods are often customized for the particular market for which they are made, and are unsuitable for use in other markets. This too harms the reputation of the brand and the manufacturer.
  3. Grey market goods often have different warranty protection — or none at all — when sold or used outside the market for which they were made. This causes customer frustration and dissatisfaction.
  4. Grey market goods sometimes are of lower quality (hence the lower price), which harms the reputation of the brand and the manufacturer.
  5. Grey market goods often interfere with the business expectations of the original manufacturer and its licensees.

In Part 2 of this series, we’ll examine how China regulates grey market goods.

China IP lawyerClients often ask us which of their entities should own their IP (patents, trademarks and copyrights) in China. The basic answer is usually simple: whichever entity will be using the IP in China.

There are some perfectly legitimate reasons for wanting to separate the ownership and exploitation of IP rights – reasons related to tax, liability, or corporate structure. But in the vast majority of situations, the only time IP ownership matters in China is when you are trying to enforce your IP rights. Chinese lawyers are expert at creating delay, and they know exactly how to exploit evidentiary gaps. And if you are attempting to bring an enforcement action in China but the plaintiff is not the registered owner of the IP, expect your dispute to take much longer than usual.

The Chinese lawyer on the other side will likely argue that someone who is not the registered owner of the IP cannot bring an action to enforce the IP rights and the mere fact the companies are under common control won’t be sufficient. A properly drafted license agreement might be sufficient – so long as the agreement is written in Chinese, registered with the appropriate authorities in China, enforceable under Chinese law, notarized, and authenticated by the Chinese Embassy, and so long as you do not run into any use issues. See China Trademarks: When (and How) to Prove Use of a Mark in Commerce. You can probably guess how often all of these things are done and done right by American and European companies. Most of the IP license agreements we are asked to review – no matter whether the company that comes to us is a two-person startup or a Fortune 100 company – are in English and governed by the laws of whatever country the plaintiff is in.

You better believe the Chinese lawyer for the Chinese company you sue in China for infringing on your China IP will be questioning each link in the evidentiary chain of your IP and pointing out each potential problem. If you’re lucky, you’ll have the chance to fix each of these problems in time before you sue, but doing so could add weeks or months or years to the process. And meanwhile, the infringing party will be going about their business using “your” IP. It’s death by a thousand (paper) cuts, and it’s a losing game.

Unless you have a really good reason to split ownership and use of your China IP into different entities, just keep it simple and use one company.

China contract lawyers
Too many China contracts deserve this appellation

Pretty much every week, at least one of our China lawyers will — after a five minute review — have to tell a potential client their contract is worthless. We see all kinds of worthless contracts. NDA and NNN Agreements, Manufacturing Agreements, Licensing Agreements, Distribution Agreements, Product Development Agreements, Employment Agreements. It goes on and on. And as tempted as I am to ask why they would think a US law contract that calls for disputes to be resolved in Boston or Des Moines would make sense in China, I always refrain from doing so, and I have seen some doozies, including the following:

  • A Seattle company that was being sued by about a dozen of its China employees and its employment contracts were drafted in English under Washington State Law. Their Seattle lawyer had told them that he had drafted their employment contracts this way because China “has no real law.” I explained their problem by pointing out how my law firm cannot hire Chinese people in Seattle and use Chinese law to pay them a dollar an hour because that is the minimum wage over there. They got and we ended up settling as quickly as we could with all of their China employees.
  • Countless companies that have used US or European style NDA agreements and have had their IP or trade secrets stolen by the Chinese company that signed that NDA. They want to know their chances of prevailing in a lawsuit against the Chinese IP thief and I have to tell them that unless the Chinese company has assets in the United States (and incredibly few do), it would probably not be worth it to them for our China lawyers even to look at their agreement. I then explain how China does not enforce United States court judgments and if they are going to continue doing business in China or with China they can do better the next time with a China NNN Agreement.
  • An American company that was using a Chinese company to market and sell the American company’s product in China came to us after the Chinese company had started selling its own products under the American company’s name and was refusing to cease doing so, even though the distribution agreement between them prohibited exactly that. The American company wanted to retain our China legal team to make this stop, but we had to tell them that we probably would not be able to succeed at that because their distribution agreement provides for US law and US court jurisdiction and because the Chinese company had registered the American company’s brand name as its own Chinese trademark. See How To Protect Your Trademark In China; How To Stop Your Distributor From “Stealing” Your Trademark.

Oh and one more thing. Far too many times when we tell someone how their contract precludes us from being able to help them, they tell us something like “we knew it would not work but we knew we needed something.” Wrong. Many times no contract at all is better than a bad contract. 

China has its own laws and its own official languages and its own court system and its own way of doing things, just like every other country in the world. So if you are going to do business in China or with a Chinese company, you almost certainly will need a contract that satisfies China’s legal requirements. There is nothing our China attorneys hate more than having to tell potential clients there is nothing we can do, but we have to do this all the time when given contracts that were not written with China in mind.

Please don’t let a worthless contract happen to you.