US-China trade warTo say that my law firm’s international trade law team has been busy lately would be like saying the Great Wall of China is long. They have been crazy busy because the United States has gone wild with trade case against Chinese companies and their U.S. importers — and against other countries and their importers as well.

If you import products from China, listen up.

US Importers of Record are liable for antidumping and countervailing duties tied to the product they import. The Importer of Record is the company listed in Block 26 of the U.S. Customs 7501 form.

Under US Antidumping, Countervailing Duty and Customs laws, the Importer of Record must exercise reasonable care in importing products and in filling out Customs forms. The Importer of Record must correctly state a product’s country of origin and also whether Antidumping and Countervailing duties apply to the imported product. A knowingly false statement on a Customs form constitutes criminal fraud.

If AD or CVD rates go up in a subsequent review investigation, the Importer of Record is retroactively liable for the difference, plus interest. Retroactive liability for AD and CVD cases is a particular problem involving goods imported from China because the United States treats China as a non-market economy country. Since China is a non-market economy country, the U.S. Commerce Department refuses to use actual China prices and costs to determine whether a Chinese company is dumping. All this makes it nearly impossible for U.S. importers to know whether it is bringing in dumped goods. See Don’t Get Crushed When You Import.

In the last week or so, the Trump trade war has escalated big time with new U.S. antidumping and countervailing duty cases being filed against Mechanical Tubing, Tool Chests and a new Section 232 National Security case against all Steel imports. These trade cases move and at warp speed and that means that if your company shows up as the producer or the importer on any of these cases, you have no time to waste. A brief summary of each of these three cases follows.

 1. Cold-drawn mechanical tubing from China, Germany, India, Italy, Korea and Switzerland. On April 19, 2017, ArcelorMittal Tubular Products, Michigan Seamless Tube, LLC, PTC Alliance Corp., Webco Industries, Inc., and Zekelman Industries, Inc. filed Antidumping and Countervailing Duty cases against hundreds of millions of dollars of cold-drawn mechanical tubing from the six countries in 2016.  The petition alleges antidumping duties ranging as follows:

  1. China: 88.2% – 188.88%
  2. India: 25.48%
  3. Italy: 37.23% – 69.13%
  4. Germany: 70.53% – 148.32%
  5. Republic of Korea: 12.14% – 48.61%
  6. Switzerland: 40.53% – 115.21%

The cold-drawn mechanical tubing covered by the complaint is used to produce numerous different products in the United States, including auto parts and machinery.

The United States International Trade Commission (ITC) will conduct its preliminary injury hearing on May 10, 2017 and US importers’ liability for countervailing duties on imports from China and India will start on September 16, 2017, and Antidumping Duties will start on November 15, 2017. Antidumping and countervailing duty orders can last for 5 to 30 years. These sorts of duty orders can and often do mean the end of U.S. imports and sales for many of the named companies, especially those that do not fight the cases against them from the very beginning.

2. Tool chests from China and Vietnam. On April 11, 2017, Waterloo Industries Inc. filed Antidumping and Countervailing Duty cases against hundreds of millions of dollars of imports of certain tool chests and cabinets from China and Vietnam. The ITC will conduct its preliminary injury hearing on May 2, 2017 and US importers’ liability for countervailing duties on imports from China and Vietnam will start on September 8, 2017 and for Antidumping Duties on November 7, 2017.  

3. National Security Section 232 case against steel imports from many countries, including China. On April 20, 2017, President Trump announced a new trade investigation of steel imports under section 232 to determine if tariffs should be imposed because increased steel imports pose a threat to national security. If the United States Department of Commerce determines that steel imports are a threat to national security, President Trump will be empowered to levy high tariffs and quotas on imports of steel products from various countries. Under Section 232, the Commerce Department will investigate the potential national security threat posed foreign steel entering the U.S. market and then issue its findings and recommendations  to the White House. Once Commerce completes its review President Trump will have 90 days to decide whether to accept or reject its recommendations and to impose trade restraints, including tariffs or quotas on steel imports.

If your company has been named in any of these three cases and you want to avoid having to pay massive duties and/or just walk away from the U.S. market for five to thirty years, you need to start organizing your defense NOW.

international Trade lawyersEmboldened by President Trump’s promise of tougher enforcement of U.S. trade laws, a fresh wave of new antidumping and countervailing duty (AD/CVD) petitions were filed in March by domestic U.S. industries seeking relief from imports. The petitions cover five products (silicon metal,  aluminum foil, biodiesel fuel, wire rod, and carton closing staples) from all over the world from Argentina and Australia, to the UAE and UK. And of course, China. These petitions will trigger 25 separate AD/CVD investigations at the Department of Commerce.

However, one of President Trump’s first executive orders was to freeze hiring of any new or replacement federal government employees.  If this hiring freeze continues, the Department of Commerce (DOC) may not have enough manpower to administer all these new AD/CVD cases. The DOC already has about the same number of on-going investigations that must be completed, along with an even bigger number of administrative reviews of all the existing AD/CVD orders that are still in effect. For each case, a DOC case analyst and attorney must draft and issue multiple rounds of questionnaires, review the responses and comments submitted, analyze all the issues raised, calculate AD/CVD margins, and draft decision memoranda.  All these necessary tasks require a certain minimum amount of time to be completed. Without reinforcements, the expanding new case load threatens to stretch the DOC trade remedy team well past a reasonable or manageable work load.

Nine U.S. Senators have already asked President Trump to lift the hiring freeze for trade enforcement personnel at a variety of agencies such as DOC, Customs and Border Protection, USTR, and Department of Justice. They specifically noted that these agencies have been tasked with more extensive trade enforcement responsibilities, but the hiring freeze would have the effect of reducing the resources available for such enforcement.

Since the hiring freeze does not apply to military personnel or those deemed essential to security, maybe President Trump will find trade enforcement is essential to national security or carve out some other exception to allow new hires for the DOC and other trade related agencies.  But if the DOC cannot hire enough personnel to administer cases properly, then perhaps it will develop leaner and meaner ways to handle these new AD/CVD cases. That is the fear of the international trade lawyers at my law firm and elsewhere, and it should be the fear of any company, Chinese or otherwise, that finds itself caught in the crosshairs of an AD/CVD petition.

For example, DOC may now try to decide more cases based on applying total adverse facts available (AFA), after finding the respondent exporter or producer to be non-cooperative because their questionnaire responses are deemed untimely or inadequate. Making this sort of finding will allow the DOC to avoid crunching all the submitted sales and cost data to get AD/CVD margins that often are not that high (particularly for non-Chinese market economy cases). This will give the DOC the highest AD/CVD margins possible with the least amount of work if the exporter/ producer gives up or is given a death blow.

Even if a respondent survives the questionnaire process and avoids a total AFA determination, the DOC now can generate higher AD/CVD margins by applying a new trade law provision which allows it to find a “particular market situation” justifying an upward margin calculation adjustment. This is what Peter Navarro, head of the newly formed National Trade Counsel, recently urged Secretary of Commerce Wilbur Ross to do in an on-going administrative review of Korean OCTG oil drilling pipe. In that case, Navarro and the domestic pipe producers wanted the DOC to make a “particular market situation” finding the Korean pipe producers benefited from subsidies embedded in their purchases of Chinese steel. Navarro relied on a “logical” presumption that the Chinese steel subsidies of 60% found in a prior unrelated case would be passed through to benefit the Korean pipe producers to generate a margin of at least 36%. Navarro’s back of the napkin calculation lacked even a napkin to support the calculation. Respondents in that case complained that Navarro’s email was an unprecedented intervention and an overt suggestion that DOC calculate a politically acceptable but factually unsupportable AD/CVD margin.

U.S. AD/CVD cases have long had a reputation for being more objective and fact/data intensive than those conducted by most other countries. But if political pressure and personnel limitations push DOC to make more arbitrary AFA determinations or politically motivated findings of a “particular market situation” U.S. trade remedy cases will soon lose any advantage of perceived objectivity or credibility. The Department of Commerce already has significant discretion to weigh the record evidence and make judgment calls favoring the domestic industry. But at least those judgment calls have been based on an analysis of specific record evidence. The new “particular market situation” provision appears to give DOC even more discretion to make adjustments based only the thinnest of factual basis. This shift towards a more politically-driven AD/CVD process may result in the Department of Commerce issuing higher margins in the short term, but over the long term, the AD/CVD process risks losing significant credibility. Trade remedy cases, by definition, are intended to be remedial, not punitive. DOC’s AD/CVD process is supposed to determine the “fair” normal value for subject imports. If DOC’s definition of a “fair” export price is not factually or legally based, but is instead arbitrarily determined by politically influenced adjustments, an exporter or US importer has no way to determine whether or how their pricing should be adjusted in order to be deemed “fair” by DOC.

What this means in real life for Chinese companies sending products to the United States, and to those who import products made in China, is that they need to be even more careful not to run afoul of U.S. AD/CVD laws and pricing. And when tagged for any AD/CVD violation, it is more critical than ever that they respond quickly and with as many facts as they can muster, thus making it harder for the DOC to make quick and random and financially deadly decisions.

China lawyersNo idea why but we have lately been seeing an increase in clients interested in getting their products from China anonymously. These companies want to have their products made in China without anybody knowing who in China is making them, and sometimes that that they are being made in China at all. There are many reasons why companies seek an ultra-low profile when having their products made in China, including the following:

1. They do not want their buyers to know that the products they are buying are made in China. But what about place of origin requirements? What about them? If you are selling an item that says “hand burnished in the United States” most of your buyers will believe your product is made in the United States even if all you do to hand burnish them is to have some $8.90 an hour employee (perhaps even from China) spend five seconds running a clothe over your product before it goes on retailer shelfs. There are plenty of items that people buy all the time without realizing they come from another country. For example, about 90 percent of seafood sold in the United States is imported, yet in my experience pretty much nobody realizes it is even more than half. Whenever someone tells me that they refuse to eat anything made in China I tell them that if they eat garlic or anything with garlic, they do eat something from China. About 80 percent of garlic in the US comes from China and that number is almost certainly considerably higher when it comes to processed and frozen foods. The point is that many (most?) companies that are completely truthful about where their product would prefer their buyers not know their products come from China.

2. They do not want their competitors to know that their products are made in China and they especially do not want their competitors to know exactly where in China their products are made. This is incredibly common. If you are making better widgets than any of your competitors and selling them at a better price, you can bet your competitors want to know how you are pulling this off. And if you are accomplishing this by using a super high quality super efficient Chinese manufacturer, you can also be that your competitor(s) would seriously consider using your same Chinese manufacturer if they could find out who it actually is. I cannot tell you how many times one of our China lawyers has asked a client how it chose XYZ Chinese manufacturer and gotten the following sort of response: “Well, company X is the leader in our industry and so I tracked down who company X uses in China to make their widgets and I went to them to have them make our widgets too.”

3. They do not want their Chinese manufacturers to know where their products are made in China. I’m being somewhat facetious here, but not really. In fact, it is this reason that has been driving the increase in clients seeking China manufacturing anonymity. They want to have portions of their product(s) made by three to six different Chinese manufacturers, without any of the manufacturers knowing about the others and without any of the manufacturers knowing to what use its portion will be put.

But all of the above is easier said then done, and I would estimate that most SMEs do not achieve the secrecy they seek, either because they mess up somewhere along the way or because doing so is simply too expensive.

The below are the pressure points where we see companies frequently fall off the secrecy track:

  1. The initial email to a potential Chinese manufacturer. Yes, the initial email. If your name is Luis Twederluski (I made that name up so please don’t even bother to look it up) and you send out emails to ten companies in China from your LuisTwederluski333@gmail.com account, you have probably already revealed more than you wanted. From just your email address, there is a good chance someone can figure out your full name (this is oftentimes possible even if your email address is goshijustreallyloveparis@gmail.com). And then from your full name there is a good chance they can figure out your company name and from that what you are intending to have made in China.
  2. The parts in your product. Take the company that does not want anyone (especially its China constituent part suppliers) to know what it is making. This company has company A in Suzhou make part 1, Company B in Xi’an make part 2, Company C in Dongguan make part 3, and company D in Shenzhen make part 4, and then it calls it a day. Wrong. What if one of these companies somewhere stamp their name on the parts that are going into the product? What if even without any stamping of names their parts are identifiable by those in the industry? The more typical problem with having 3-6 companies operating completely independently of each other is cost. If you are a large company with personnel who can coordinate logistics, timing and interoperability of parts between your various suppliers, then you should be covered. But if you are a small company and you think you can coordinate all of this things will sitting home in Pittsburgh, well that just isn’t terribly likely. Most importantly, where are you going to put the 3-6 parts together into your product and then have it packaged? If you were thinking of doing these things in the United States for anything near to as low a price as you would pay in China, well that is not likely going to happen.
  3. Importing the product into the United States. It never ceases to amaze me how few people realize how easy it is to review import records on the web. Just by way of an example, Google search “Lululemon (which is NOT a client of our firm) import records” and the first item will take you to www.importgenius.com which for free shows you a “sample shipment record” showing Lululemon imported “hustle pants” from Mactan Apparel out of Taiwan, but the pants actually came from Cebu, Philippines. If I actually cared from where Lululemon gets its products, my next step would be to sign up and pay for Import Genius (there are other search services as well) and then start going through all of Lululemon’s import records. Your competitors might be doing that with your import records even as I write this. We have had client companies tell us of the amazing lengths they have gone through to keep their name off U.S. import records. A few years ago it was the rage to form a company in Hong Kong and have that HK company buy your products from the PRC manufacturer and then have the PRC manufacturer actually ship your products to your Hong Kong entity and then that way the US import records would not reveal the name of the PRC manufacturer because your own HK company would be the exporter. There was (and still is) usually a far easier way, especially if you are in a large industry. Let’s say your company is called World’s Best and Finest Toys and you sell toy dolls that you have made in China and you do not want your competitors (or anyone else for that matter) to know from which toy factories you are getting your dolls. You can set up an import management company and call it World’s Most Mediocre Hamburgers and Kielbasa’s and use that company to import your dolls. This is a cheap way to make it far harder (perhaps impossible) for anyone to know what you import.

A word of warning is definitely in order though: some of these methods may not work or may even be legal for your particular industry or your particular country or may increase your taxes or just otherwise make your life miserable. In other words, don’t anyone write me an email months from now saying (and I do get these) I did what you told me to do in this [link] blog post and now I am wondering if….” The above are examples; I am not telling you to do anything at all. In fact, I am telling you that you will be making a huge mistake to do any of these things without first consulting with an international trade law attorney and with your tax professional.

The goal of this post is not to solve your product secrecy problems but rather just to get you thinking about the issues and not to blow your cover with your first email.

What do you do to maintain your product secrecy?

China manufacturing lawyers
China product manufacturing: the tensions are rising

We often write about the increasing sophistication of China contract manufacturing. Fifteen years ago, the typical US-China manufacturing agreement involved the sale of socks or rubber duckies. Today, the typical contract involves a complicated electronics device involving hardware and software and all sorts of intellectual property and much greater risk of defect and injury than a pair of socks.

With the increasing sophistication of China manufacturing and China manufacturing contracts has (not surprisingly) come increasing business and legal sophistication by Chinese manufacturing companies. Two to three years ago the overwhelming majority of manufacturing contracts my firm’s China manufacturing lawyers wrote were accepted either unchanged or with only minor changes by the Chinese side. Today, Chinese manufacturing companies better understand the legal impact of the contracts they sign and they are becoming increasingly reluctant to sign contracts that pin major potential liabilities on them.

Today’s post is about liability issues for defects, which issue our China manufacturing lawyers are dealing pretty much every day and which issue is truly on the front lines in terms of the contract “war” that has broken out between China manufacturers and their foreign company buyers. The below is an amalgamation of three recent emails we sent to companies looking to our China lawyers to reduce their product defect risks when buying from China.

 

I understand your concerns. Defect rates from China are too high.

For China, the issues surrounding product defects are usually the following

1. You need a Chinese language, Chinese law agreement you can enforce in China.

2. Contracts typically used in the West are usually too vague and flexible for China. For China, you need to be blunt and clear. Defect beyond some rate means a monetary penalty of some amount. If your contract is not clear on what constitutes a defect and the price your manufacturer must pay for the defects, it is not appropriate for China. Do you want just a repair/replace warranty, or do you want damages also to include the costs of dealing with the issue or do you want it to include all the above, plus claims from customers and consumers. If ALL the damage is included, the number can be big and if the Chinese side understands this (and they probably will), there is a good chance they will not agree to it, unless you have sufficient economic leverage over them such that they feel they have no choice. Even if they do agree to it, you need to be concerned about whether they have the money or the insurance to pay on any major problems.

3. One of the biggest issues for China is how to enforce your defect contract provisions. We typically propose something like the following:

Step One: Determine a sum certain amount owed based on a mechanical formula. Calculation is entirely in our client’s control with no good faith participation by the Chinese side.

Step Two: Report the amount owing to the Chinese supplier through a formal invoice. Do this on a regular basis, say every quarter.

Step Three: Collect the amount owing. The most common way to do this is to apply the amount owing as a credit against the invoice for the defective product, against current invoice amounts, and against future invoices.

Step Four: If step three does not cover the amount, send an invoice for the remaining amount. If the invoice is not paid, file suit in China. If the lawsuit is based on a sum certain amount even the threat of the lawsuit can have some benefit.

You can see how the above can work well for what you are seeking to accomplish, but Chinese factories and Western buyers are in major battles now over defect issues. The Chinese manufacturers are concerned with agreeing to sell on a net 30 or net 60 or net 90 basis and then having the foreign side refuse to pay because of claimed defects. The Chinese is legitimately concerned with the foreign side using the defect issue to reduce payments actually owed. All of this is right now a hot topic within the Chinese export factory community so the odds are good that your China factories will be sensitive on these issues.

We should discuss the above and then formulate a strategy for dealing with your China manufacturers.

 

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 NNN Agreement Lawyers
How to execute a China NNN Agreement

This post is nothing more than described in the title. It focuses on what you typically should do by way of contract signing formalities for your China NNN Agreement. It answers the following question we frequently get from our blog readers and from our own clients: What exact steps should I take to get a China NNN Agreement signed?

The below is the typical response from our China lawyers:

The next step is to send this bilingual agreement to the Chinese side for review. If the Chinese side accepts all terms you should sign, date and then submit the contract to the Chinese side. Then don’t do anything — and especially do not send any confidential information regarding your product or your molds — until the Chinese side returns with a fully executed version, that it has signed, dated and chopped. You will want to make sure the exhibit listing your confidential information is properly filled out and dated, signed and chopped by the Chinese side. And you want to make sure of this not only at the time of first execution, but also every single time a new product item or a new mold item is entered onto the record. For your own protection, you will want to make sure you in the end hold on to at least one original, fully executed agreement.

Please note that though the above says “bilingual agreement,” the official portion of the agreement is strictly in Chinese. The English language portion is strictly a translation for the benefit/convenience of our clients. I am careful to make this distinction because nearly all of the contracts we draft call for Chinese as the official language and we never draft contracts where more than one language is the official language. For why this distinction is so crucial, I urge you to read Silly Rabbit, The Chinese Language Contract Is What Matter and Dual Language China Contracts Double Your Chance Of Disaster.

How to sell to ChinaThis is the first in an eventual series of posts I will do on the business and legal issues related to foreign companies selling high value equipment to Chinese companies. The behavior of Chinese companies in this area is quite uniform, and it is therefore possible for me to present a uniform approach to sales into China. Before moving to a detailed analysis, it will be best to step back and consider how Chinese companies view the process. Once the fundamental viewpoint of the Chinese side is understood, it is then much easier to determine how to craft an effective sales strategy for China.

Chinese companies purchased a fair amount of advanced equipment from foreign companies in the 90s. But these purchases slowed considerably as Chinese companies shifted their focus to manufacturing for the export market. However, these export oriented Chinese companies have recently started showing a renewed interest in purchasing advanced equipment from foreign manufacturers. That China is now Germany’s largest trading partner is good proof of this.

The reason Chinese companies are buying more advanced equipment from overseas is clear to anyone who visits Chinese factories. The simple truth is that much of the production equipment in these factories is old technology nearing the end of its useful life. The Chinese businesses that have made China the factory of the world have  pushed their manpower and outdated tools to the limit and for them to continue to compete in the world manufacturing market, technical upgrades are required. Chinese companies are mostly unable to innovate in this area on their own; so they are reluctantly making purchases from foreign entities.

Though the world has greatly changed since the 90s, the attitude of Chinese companies towards the purchase of foreign equipment has not. There are five basic beliefs that drove Chinese advanced equipment purchases back when I was working on them in the 1990s and those same five basic beliefs drive these purchases today. Once these beliefs are understood, Chinese behavior on these equipment transactions becomes easy to understand. Once you understand the basis for the behavior of your Chinese counterpart on these deals, you can design a program that can be successful in the Chinese market.

In entering into a sales agreement with a Chinese factory interested in buying your high value equipment, you should understand that the Chinese factory owner almost certainly holds the following five fundamental beliefs that will drive its behavior in the sale process:

1. Your price is unfairly high. The important thing to know is that the Chinese side believes your price is both too high and fundamentally unfair. The Chinese side views this as the legacy of foreign imperialism, designed to keep the Chinese down, always under the thumb of the foreign oppressor. This attitude is supported by the general ideology of the PRC government. Under this basic belief, the Chinese factory owner feels morally justified in working to avoid paying you the full price for the equipment.

To achieve this, the basic strategy of the Chinese side will be the following:

a. Insist on paying in installments, then not paying the last installment.

b. Insist on a major discount, in the range of 30% to 40%. This then becomes the new base price for the equipment.

c. After paying the discounted price for the first two units, insist on an additional discount for future purchases.

2. Training is not necessary. Any requirement for training the Chinese side in how to use your equipment is just another way for you to unfairly extract more money from the Chinese side. It is also a way to keep the Chinese side down by showing that the Chinese have something to learn from foreigners. The Chinese believe that operation of the equipment is governed by a simple magic pill. Foreign companies that insist on a training program are withholding access to the magic pill.

3. Proper equipment set-up is not necessary. Your requirement that the Chinese side retain you for proper equipment set-up is a waste of time and designed to shift blame for operational failure onto the Chinese side. The Chinese side believes the equipment should “just work.” For this reason, elaborate site set up and pre-operations testing should not be required. Just turn the key and go.

4. After sale support and maintenance is not required. Requirements from the foreign equipment supplier for such after-sale support is designed to do two things: unfairly extract more money from the Chinese side and keep the Chinese side employees ignorant about the true nature of how the equipment operates. That is, you are unfairly hiding the magic pill from them. In addition, the equipment should “just work,” with no need for after sale maintenance or support. Your requiring a service contract or related after-sale support is either your admitting that your equipment is fundamentally defective or your trying to unfairly milk more money from the Chinese side.

5. Your attempts to protect your IP is foreign oppression. Intellectual property protection that prevents the Chinese side from copying your equipment is just another form of foreign oppression. The Chinese side does not believe the design of your equipment is the result of years of hard work and R&D and it wants to be able to copy it so that it can be manufactured in China at a “fair” price.

This then means the Chinese side’s standard strategy will be to purchase as few units as possible and then use its initial purchase(s) to extract the “magic formula.” The strategy is to abandon future purchases and have clones of your equipment manufactured in China.

Obviously not all Chinese companies subscribe to all five of these beliefs and some Chinese companies do not subscribe to any of them. But most do and I know this from what they have told me (in Chinese), from what I have overheard (in Chinese) and from what I have read (in Chinese). I mention all this because foreign companies find this all hard to believe and even when they do believe it, they find it hard to truly internalize and adjust their selling behavior accordingly. The typical Chinese factory owner will negotiate and implement its purchases of advanced foreign equipment based on these five beliefs. Many foreign suppliers, when faced with the resulting behavior, will conclude that the Chinese are operating in bad faith. However, to deal with the Chinese buyers, the first step is to understand that they believe their approach is fair. They are simply working against the unfair advantage of the foreign seller by making a more level playing field.

The important thing from the standpoint of the foreign seller is to recognize the following:

  1. These basic beliefs are natural and will not be changed.
  2. Since these basic beliefs are pretty much universal among Chinese companies, it is easy to predict how the Chinese buyer will behave at every critical point in the sales process.
  3. Since the approach of the Chinese side can rarely if ever be changed, foreign companies that want to sell their high value equipment to China should design their sales programs based on what the Chinese side will do, with contracts that protect the foreign seller from the negative consequences of near certain Chinese company actions.

In my next post, I will outline a basic program for achieving this.

Not entirely sure why, but in the last couple weeks our China lawyers have seen a massive increase in emails and phone calls from North American companies seeking our help in dealing with defective products/quality control problems. In this post, I explain what you (and they) need to have in place to avoid these sorts of problems in the future, and to make it possible to resolve such problems should they occur. Our China attorneys also have been receiving an unusually high number of emails and phone calls from companies being pursued by Sinosure, and I will discuss how to deal with that in a future post.

My theory is that this slew of calls is due to two things. An increase in QC problems at China factories due to rising costs. Whenever costs rise for China factories quality problems rise as well, until such time as the China companies can increase their prices to their foreign buyers. This influx of bad product calls may also simply be due to the time of year; it may just be the end of 2016 hangover. I note that our last bit tick in these calls was in February 2016. What makes this year’s version so much more interesting for us anyway, is how many of these new matters involve Internet of Things products and how woefully unprepared these companies are to deal with these problems.

I am going to try to avoid getting all preachy here, but I truly do believe that all of these companies could have avoided their bad product problems had they had a good contract in place with their China product supplier. Only one of the companies that have contacted us so far this year had any contract at all with their China factory, and that one contract called for all disputes to be resolved in the U.S. Court of the American buyer, and as we have discussed constantly on here, that is 99.99% of the time a non-starter. In Four Common (And Somewhat Deadly) China Law Mistakes To Avoid, I briefly (for me anyway) gave a real life example as to why this is such a bad idea:

A lawyer calls us with an airtight $2 million dollar breach of contract lawsuit against a Chinese company. This lawyer had drafted a contract calling for disputes between her client and the Chinese counter-party to be resolved in Boston Federal Court and she had already sued the Chinese company in Boston and secured a default judgment against it. She was now seeking my law firm’s help in domesticating the judgment in China, and It was clear she expected us to jump at the opportunity to take the case on a contingency fee basis.

That is until we told her that China does not enforce U.S. judgments. Ever.

She then came up with the idea that we start all over by suing the Chinese company again in China. We had to tell her that could not work because the Chinese court would have two strong grounds for throwing out that lawsuit. First, improper jurisdiction because the contract clearly called for the lawsuit to be in Boston. Second, res judicata because the entire case had already been tried (and won) in Boston (the proper jurisdiction). I have no idea how she explained all this to her client.

American lawyers commonly assume that what makes sense for a domestic transaction necessarily also makes sense for an international transaction. Boston would have made sense in the above instance if the counter-party had been in Los Angeles, but the rules and the issues are different when doing business internationally.

If you check out this post, China Contracts that Work, you will see that what is needed for you to have a manufacturing contract that works is for that contract to be in Chinese with a provision calling for disputes to be resolved in a Chinese court under Chinese law. Your manufacturing contract should also contain a liquidated damages provision and a mold protection provision (so that the factory does not keep your molds if there is a dispute, and be properly chopped/sealed by the Chinese side. It is also critical that your contract be with the right Chinese company as Chinese companies are notorious for signing agreements with an essentially empty shell company, usually based in Hong Kong. If your contract satisfies all of these things, the odds of your having a manufacturing problem go way way down. And if you have such a contract and you do have a problem, your odds of being able to resolve it with your Chinese factory without having to contact a China law firm for legal assistance go way way up. And in those rare instances where you do need to engage a China attorney to assist, that attorney will be well positioned to resolve your problem relatively quickly.

One more thing. Whenever someone contacts our law firm with a problem with their factory, one of the first things we always ask them is whether they have secured China trademarks for their trade name and their brand and their logo. We then explain how common it is for Chinese factories (they actually have someone else do the filing for them) to go off and register YOUR brand name and YOUR logo as a trademark so that they can use this as leverage against you or so that they can keep making your product with your brand name and your logo and sell that product in any country in the world where you have not protected them with a trademark. Sadly, about half the time we are too late and the trademarks have already been registered to someone else, making it difficult or even impossible for the foreign buyer to continue having its products made in China. For more on this critical IP issue, check out When to Register your China Trademark. Ask Tesla and China: Do Just One Thing, Trademarks. So if you have not already registered your brand names and logos in China, you should do this IMMEDIATELY and you certainly should do so before you complain to anyone there.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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