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How To Get Bad Product From China With No Legal Recourse

Posted in Basics of China Business Law, Legal News

Yesterday’s post, How to Give Away your IP in China, drew such favorable reactions that I figured I’d reprise the theme today and explain how to ensure bad product from China without being able to get compensated. But rather than write a new post on it, I will just cite a recent email (taken from a template) I use to explain to people why we will not pursue their claims against their Chinese manufacturer. This email essentially recites all of the things that the recipient did to ensure that the product it would get from China would be substandard and why once it got that product, there was little or nothing it could do to secure compensation for the quality problems.  Defective Products from China

Sorry, but we would not be interested in taking this on a contingency fee basis and I cannot in good conscience ask you to pay us to pursue it.

Our lack of interest in your case stems from the following:

1. Your contract (even assuming that this qualifies as a contract under Chinese law) is in English. Many courts in China will not hear a case with an English language contract. This is even more likely to be the case in a place like _____.  For more on the importance of your contract being in Chinese, check out China OEM Agreements. Why Ours Are in Chinese. Flat Out and How to Draft a Contract for China.

2. It looks like you did not pay the company with whom you have the contract. You instead paid some other company. This is a classic China ploy. If you sue the company with whom you have the contract, it will say that you never paid them because you didn’t. Not sure if it will win on this, but it is yet another hoop you will have to jump through.

3. The “contract” says that you will inspect the product before it ships. The Chinese manufacturer will contend that you either did inspect and were fine with it or you chose not to inspect. Either way, it should make for a pretty good defense because for whichever reason you allowed the product to be shipped to you without voicing any complaint. If you are not going to inspect product before it gets sent to you, you should not have this sort of provision.

4. China does not generally recognize samples as the standard that must be met. If you want your product to be of a particular quality, you had better lay out every single specification that will get it to that quality. As I alway say in my speeches, putting in a term like “good quality” in a contract with a China manufacturer is a waste of time because in China they have incredibly low quality levels that are just fine for Chinese commerce and for Chinese courts. It is not at all clear to me that your manufacturer failed to give you exactly what you ordered. You say that it is of bad quality, sure, but that is under US standards, not under any standards that I see in the contract and that is what is going to matter to a Chinese court. For more on why this matters and for how you should handle this the next time you have product manufactured in China, check out How To Get Good Product From China; Specificity is THE Key To Your OEM Agreement.

You might want to try to interest a Chinese lawyer in taking this case, but I have my doubts whether even that would be worth your time and money as you will almost certainly have to pay at least the out of pocket costs for pursuing this litigation. Suing in the United States would be a complete waste of time and money unless this Chinese manufacturer has assets in the United States, and incredibly few do. China courts do not enforce U.S. judgments so even if you win over here, it will be of no value in collecting money from your Chinese manufacturer in China. For more on this, check out Why Suing Chinese Companies In The US Is Usually A Waste Of Time.

If you are going to continue buying product from China, you should have a contract that will work. I suggest that you read the links within this email (now this post). What you want is a contract that the Chinese manufacturer believes will allow you to win in a Chinese Court if it provides you bad product, and win fast and win certain specified damages and be able to seize the manufacturer’s assets upon filing the lawsuit (before you even win). With that sort of contract, your chances of ever getting bad product go way way down and should you get bad product, your chances of winning at trial and getting your money go way way up.

 

How To Give Away Your IP In China

Posted in Basics of China Business Law, Legal News

We represent a large number of foreign companies that do OEM manufacturing in China. In our discussions with these companies, one of the first issues we raise is how to protect the intellectual property of the foreign party. Foreign designers of products are quite properly concerned that by using a Chinese manufacturer, they are simply training a future competitor. They are concerned that the Chinese manufacturer will appropriate their designs and start selling the same product to their own customers or to the customers of the foreign party in the United States and in Europe.  China IP Gift

As a result, we spend considerable time in training our clients in the basics of IP protection. We lead them through the basic elements involving execution of basic agreements and registration of the appropriate intellectual property instruments. When the product is an existing product of the foreign party, the response to our basic system has been remarkably good and we have had considerable success.

However, where the product is new and requires development work, we have had significant difficulty. In this area, it seems that our clients seem almost to intend to give their intellectual property to the Chinese manufacturer. Where product development is concerned, we tell our clients: you need three types of agreements: an NNN Agreement, a Product Development Agreement and an OEM Manufacturing Agreement. We have found remarkable resistance to the use of product development agreements. I personally find this difficult to understand, since it is product development that should be the area of greatest concern for intellectual property protection.

Since the foreign parties seem so interested in giving away their IP, the Chinese manufacturers have developed a very standardized system for accepting the gift. Here is how they typically do it:

The foreign party comes to the Chinese manufacturer with the basic idea for a new product. The foreign party has a basic design, but has done none of the engineering and related work required to take the design to the point where it can be manufactured in commercial quantities. In some cases, the design has not even been prototyped to determine the mechanical issues to confirm the practicality of the design.

The foreign party then requests that the Chinese side do all of the engineering and prototype work required to commercialize the product design. The Chinese manufacturer offers to do this work free of charge in exchange for a commitment from the foreign party to purchase the product from the Chinese manufacturer. The foreign side is excited. They are able to obtain high-level engineering and prototyping work at no charge. The Chinese side is happy because it has just captured a new client for a new product. The design work is not documented by a written agreement. The usual attitude is that if the product is developed in a way acceptable to the foreign party, then a formal OEM agreement will be drafted and executed. If there is no success, the foreign party will try elsewhere.

This casual approach is often a failure from a practical standpoint. The Chinese manufacturer is not being paid, so the design project is often placed on the “back burner” and the manufacturer gives its attention to it only when it has spare time. If the manufacturer is a successful company, this spare time may be hard to find. For this reason, extensive delay is common. Moreover, what exactly the manufacturer is intended to design at what standard is usually not specified. So even if the Chinese manufacturer finishes the project in a reasonable time, it is often not clear whether the final design meets the needs of the foreign party. For this reason, for any but the simplest of products, it is essential to enter into a design agreement that sets out a clear standard of performance together with specific milestones that ensure timely completion of the project.

Assume the manufacturer does manage to design and commercialize a final product. Now consider the fundamental issue: who owns the intellectual property in that product? Note that the manufacturer did all the work entirely at its own cost with no specific design agreement with the foreign party. Though an NNN agreement may be in place, the situation is at best ambiguous.

Now take this consideration to the next step. It is virtually certain that the Chinese manufacturer is a manufacturer of the same type of product that they either sell under their own name or that they sell to other foreign manufacturers. If they were not familiar with the product type, they would not have been selected for the development work. Now, the Chinese manufacturer looks at the product it designed and it decides that it would like to make this product for its own use. Why bother manufacturing for the foreign party when we can manufacture under our own name and make all the profit?

In this situation, what does the Chinese manufacturer do? As you will recall, there is no OEM or other purchase agreement in place. This then means that no final price for the product has been set. So the manufacturer simply quotes an outrageously high manufacturing price to the foreign company. In this situation, the Chinese manufacturer cannot lose. If the foreign party accepts the price, the manufacturer makes a windfall profit. If the foreign party rejects the price, the manufacturer has a new product for its own sales line.

After the foreign company rejects the price required to move forward with the Chinese manufacturer, some extremely careful Chinese manufacturers will take the additional steps required to secure the intellectual property in the product. They will register a trademark, register a copyright and register a design patent, all of which they will register with Chinese customs as well. In this way, they not have secured the product for themselves, they also have prevented the foreign party from moving to a different Chinese manufacturer to design and manufacture the product.

When the foreign party then threatens to sue, the Chinese manufacturer points out the obvious. The foreign party has no registered IP in the product. There was no written contract related to developing the product. The product was developed entirely at the cost of the Chinese manufacturer and the IP registrations were all done by the Chinese manufacturer in its name and at its own cost. The Chinese manufacturer then says “go ahead and sue us, in a Chinese court in our hometown.

Our China lawyers have seen countless foreign companies give away all rights to their designs in return for saving money on product development and avoiding having to pay their China counsel for an appropriate Product Development Agreement. What they actually have done is come to China to give away their intellectual property. Needless to say, the Chinese side is happy to accept the gift.

China’s Golden Age For Foreign Companies Is Over

Posted in China Business

Let the hate mail begin.

Whenever we write on how things are getting bad for foreign companies doing business in China and on how foreign companies should think long and hard before doing business in China, we get hate mail or hate comments (which we typically delete). Many of these come from China consultants who   sometimes blatantly accuse us of damaging their business. I have already received two angry emails for what I am about to write about in this post. Those two emails came in response to what I said in the article this post will be discussing.

The article is Nokia exit: Is China’s ‘golden age’ of foreign investment over? written by Peter Ford the Christian Science Monitor’s Beijing Bureau Chief and truly one of the deans of China journalism. As you can tell by the title, the article examines whether China’s golden age of foreign investment is over. Doing Business in Vietnam

There is no disputing that China’s golden age for foreign companies doing business in China is over. China today is just not nearly as favorable or easy for foreign companies as it was ten years ago. It just isn’t. But that does not in any way mean that there are not a wealth of opportunities for smart companies to make money in or from China or to save money by using Chinese manufacturers.

In my mind — based largely on what my own firm’s China lawyers have seen over the last ten or so years, I divide China into the following three “eras” for foreign companies from the perspective of my own law firm:

1. The initial era, which lasted until around 2008. During this era, many foreign SMEs were operating completely illegally and off the gird in China and when we told them what would be involved in our getting them legal, most chose to continue operating illegally. There was a gold rush mentality and whether operating legally or illegally (and back then the distinctions were not so clear cut), it seemed that all or at least nearly all of our clients were thriving in China. Few companies understood or cared much about protecting their IP in China; they believed it was hopeless.

2. The transition era. This era was from around 2008 to 2013 or so. Some remnants of the initial era remained, but were in decline. Of those who called our China attorneys about what it would take to start operating legally in China, around half chose to make the necessary changes to get legal with the other half choosing to keep operating as they were, “at least for now.” Many foreign companies began realizing the importance of registering their trademarks, copyrights and patents in China.

3. The current era, starting roughly in 2014. Despite China’s downturn, and despite our law firm getting fewer contacts from potential clients, our workload has greatly increased. Three things explain the increased workload. One, Virtually all foreign companies now realize that they must either get legal in China or leave — no more operating illegally “for now.” And two, getting legal has become a lot more complicated and work intensive, which means more attorney hours.  Three, virtually all companies not only understand the importance of protecting their IP in China, they actively wish to do so. Virtually all companies also now understand the importance of having an enforceable China contract when doing business with Chinese companies.

So despite China constantly getting tougher on foreign companies and despite it making sense for many more foreign companies to leave China or not go there at all, my law firm’s China practice continues to grow and — believe it or not — so does foreign investment into China. Why should this paradox be true?

Because what is happening with foreign investment into China is not so much a shrinking but a maturation. Call it the end of irrational exuberance if you like, but whatever you call it, what is happening is that those companies that never should have gone into China in the first place are now largely gone or are in the process of leaving, or at least seriously considering doing so. And now those companies looking to go into China or to have their products manufactured there or to sell their own products and services there are looking into China for all the right reasons.

China still has 1. 5 billion people and there are still countless companies that should and do salivate at selling their products and services to China. But there is also the realization that doing so will not be easy, fast or cheap. China is still the factory to the world, but it is not the only country in which it makes sense to manufacture and companies are increasingly realizing this.

Peter Ford’s article nicely reflects all this. It starts out focusing on Microsoft shutting down two of its China cell phone manufacturing facilities and moving that production to Vietnam. Ford describes this move as the “latest sign that for international companies, China is losing some of its luster after years of shining as the brightest star in global capital’s firmament.” But he quickly follows this up by noting that “China is still a huge, growing market that no global company can afford to ignore. Its economy, the world’s second largest after the US, is expanding at around seven percent a year.” There you go. China is no longer THE country for everything and everybody but it is still the country for many companies and for many things.

Ford then lists the following as some of the concerns foreign companies have about doing business in China:

  • air quality. Check.
  • restrictive rules. Check.
  • higher costs of business. Check.
  • obstacles on market access. Check.
  • China has become a tougher place to do business. Check
  • China’s economy isn’t growing as rapidly. Check.
  • Chinese laws are unclear and often arbitrarily applied. Check, sometimes.
  • foreign companies are being singled out. Check.
  • foreign firms are being kept out of some of the most lucrative investment opportunities in China’s service sector. Check.
  • foreign businesses are less welcome than they once were. Check.

Does anyone really dispute that all or at least almost all of the above list is accurate? But be that as it may, what really determines whether a foreign company goes into China or stays in China is money. If the money is there and the foreign company can legally stay in China, it usually will. If the money is not there, it will eventually leave. Much of the above list has been true to some extent for ten years and nearly all of it has been true for five years. What has really changed is that foreign companies are being hit with so much from so many angles that they are having to decide whether to stay or not. Some are leaving but way more are staying.

What sorts of companies should stay or enter China and what sorts of companies should leave or not enter at all?

According to Ford, “Microsoft’s decision to decamp to Hanoi was doubtless influenced by lower production costs there. The Japanese trade agency JETRO found in 2012 that Vietnamese wages were around one third of Chinese wages.” Vietnam crushes China when it comes to wages. But if wages were the only factor in Western companies choosing where to locate, Microsoft would have moved its facilities to Yemen. Microsoft no doubt chose Vietnam for the same reasons Intel and so many large Japanese companies chose it years ago. Vietnam has a good workforce. Vietnam is a safe country. Vietnam has a growing economy. Vietnam has good (not great) political stability. Vietnam is a US ally (it really is). Vietnam has decent (though certainly not good) logistics. Vietnam has a growing consumer economy and it is a good base for selling into Cambodia and Laos and Myanmar. Doing business in Vietnam igets easier pretty much every year. Both Hanoi and Saigon are considerably cheaper cities for expats than Shanghai or Beijing.

Consumer facing American companies face similar (but different) problems in China:

But at the same time China is getting more competitive and harder to sell into, says Sage Brennan, head of China Luxury Advisors, which helps luxury goods companies break into China. “It is no longer the untapped marketer’s paradise that it once was,” he says.

One US company making that unwelcome discovery is GoPro, makers of miniature action cameras. The firm had barely begun to expand into China when Chinese mobile phone maker Xiaomi last week unveiled its own Yi Action Camera, selling for half the price of GoPro’s basic model.

The article quotes me regarding American companies moving from China to Vietnam:

Lawyer Dan Harris, who helps small and medium sized American companies operate in China [and with the help of an experienced Vietnam lawyer, to Vietnam as well], says that most of the businesses here he has helped to wind up have closed because of disappointing local sales, not because they are moving elsewhere.

Smaller firms cannot afford to move abroad because they have made big investments to establish themselves in China, Mr. Harris says. Nor are they big enough to take sufficient advantage of lower per-unit production costs to make a move from China to Vietnam worthwhile, as it has been for Microsoft, Intel and Samsung, among other global firms.

“But if the big companies go, the feeder firms will want to go too,” says Harris. “Eventually my clients will have to follow them.”

In my interview with Ford I talked about how Vietnam is great for huge companies like Panasonic and Canon and Toyota, which all have massive facilities outside Hanoi. It is also great for a massive company like Intel which by all accounts is doing well in Vietnam these days. Those companies have all the resources to figure out Vietnam and to work with the government to make things work for them there. These companies can essentially bring in or create in place much of the infrastructure they need.

 

SMEs on the other hand, typically need a fair amount of outside help to navigate Vietnam initially and so at first Vietnam can be more difficult than China. China has made it easy for foreign companies. Vietnam is still working at that. If a client asks me for a good China supply chain person, I can give them one in a heartbeat. If a client asks me for a good China sourcing person, I have lists ready to go, depending on the product. If a client asks me for a Beijing based accountant who knows both US and China accounting. I have a list for that too.

Vietnam can be more difficult. I have had American companies come to me to draft their manufacturing contracts to have kitchen products or shoes or t-shirts or toys made in China that they could be having made for lower cost in Vietnam. When I ask why they chose China rather than Vietnam their response is often something like “we would love to go into Vietnam but we really don’t know how to do it and we have this guy we trust who has already done xyz in China and so it will be easier and cheaper in the short run for us to just go to China.” But we are also seeing some of our medium size manufacturing clients whose manufacturing costs are rising in China looking to Vietnam to replace or supplant their China facilities. We are also seeing some of our clients that are doing well in selling their products or services in China looking to Vietnam to expand.

I could go on and on about China versus Vietnam and what sorts of companies should be choosing which country but this post has already gotten too long. So I will instead conclude with the conclusion to Ford’s article:

“A company puts its resources where it thinks its future market will be,” says Mr. Brennan. “China is not going away, but it is becoming just one market among others” while countries such as Indonesia offer the prospect of faster revenue growth.

“So far, companies have been focusing on China,” Brennan adds. “Now they are looking at southeast Asia and India too. We are seeing a groundswell shift in what companies are spending their time on.”

So true. What are you seeing out there?

For more on where to locate your business in Asia and on Vietnam as a choice, check out the following recent articles:

China Law Updates/Ramblings

Posted in Good People

Met with two old friends this month, both of whom have the following in common:

  • They were both born in China and did their undergraduate work at top schools there.
  • They are both now American citizens and have lived between the U.S. and China for the last 20 or so years.
  • They both have a highly technical Ph.d from top U.S. schools.
  • They both are super-smart and honest to a fault.

    Photo for represenative purposes only

    Photo for representative purposes only

I had a great conversation with both of them (at separate times) and the takeaways were as follows:

1. Economic and business mood in China is okay. There is concern about the economy but not fear.

2. Everyone is taking the anti-corruption crackdown seriously. It has not come close to rooting out corruption, which remains pervasive, but it is a making a go of it. The populace generally favors it, or at least that is what everyone is saying.

3. Chinese and foreign businesses are taking the increased emphasis on rule by law seriously. When I said that our China lawyers were dealing with what seems like a never-ending influx of new WFOE formation work, neither seemed at all surprised and one even correctly guessed that many of our clients had been doing business in China for years and had just recently concluded that the costs of formalizing that business with a WFOE were less than the risks of having to argue to a government official that no WFOE was necessary.

4. China is not innovating. It is still just copying. I was surprised to hear this from both of them, but they insist this is the case. One even analogized it to the Beijing silk market, where the goods are pretty much all the same and the only attempts to differentiate are on price. This person said that someone really high up at the last Chinese company for which he worked once told him that the only reason the company had been formed and was able to do so well its first few years was because it was undercutting everyone else by 10-20%. But when people starting realizing that the quality just was not there, its market share plunged and never recovered.

5. China’s big cities are getting expensive. Beijing and Shanghai now cost nearly the same as New York.

What are your thoughts on the above?

UPDATE: Right after I posted this, I read this article, entitled, China’s transition to new innovation powerhouse, which in turn reminded me of this article, Will Apple’s Business Model Work In Pharmaceuticals? written by my friend and China health care guru, Ben Shobert. The first article is a rah-rah portrayal of China as a top down innovation powerhouse. Shobert’s article is an in-depth nuanced article on China’s efforts to become a pharmaceutical powerhouse. This all leads to the big and eternal question: is China innovating or just copying? To a certain extent it is doing both, but what is the ratio — assuming one can even describe this as a ratio?

Justifying China Bribery

Posted in Basics of China Business Law, Recommended Reading

China Bribery

I met Richard Bistrong while both of us were speaking at last year’s Dow Jones Global Compliance Symposium and I have been reading his blog ever since. Bistrong’s blog provides “An International Perspective on FCPA, Anti-Bribery and Compliance.”

Beyond knowing a ton about these subjects, what makes Bistrong and his blog so interesting is his perspective. If you go to his blog’s about page, you will see a long list of truly salutary credentials and achievements, but among them you will also see the following:

Pleaded guilty and sentenced to one count of Conspiracy to violate the FCPA, including books and records as well as exporting goods without authorization.

Though I hesitate to focus too much on this one aspect, it does instantly give Bistrong a “credential” or even a street cred that few others have. I mean, this alone means that when it comes to issuing the warning that people can and do get caught all the time for FCPA and other anti-corruption violations this is a guy who knows whereof he speaks.

My reason writing on Bistrong today is his most recent post, Bribery, Beneficiaries and Guilty Feelings (or lack thereof), in which he explains how easy it is for people to slide into justifications for paying bribes. I have no doubt many of you will read this and say “that could never happen to me” or that it is not as easy to justify as Bistrong makes it out to be, but I will tell you that I have heard from people doing business in China pretty much all of the rationalizations that Bistrong lists. I will also tell you that as a lawyer I am of the strong view that knowledge is power and that preparing for worst case scenarios is the best way to avoid them.

Bistrong’s blog is very powerful and I recommend it.

China And US Film And TV Content Event: Beijing on March 18

Posted in China Film Industry, Events

Mathew Alderson, who heads up our China media and entertainment practice, will be moderating a panel of leading experts discussing the “issues faced by creatives and producers when developing content suitable for audiences in both China and the US.” This AmCham event is called Creating Film and TV Content for Audiences in Both China and the US and it take place at AmCham (Beijing) on March 18, from noon until 2:00 p.m.  China TV

The panel will consist of the following:

  • Daniel Manwaring. Daniel is a Corporate Development Executive at Creative Artists Agency (CAA) who works in the Beijing office focusing on cross-border business opportunities for the agency’s clients in the international marketplace.
  • Joe Wong. Joe hosts the CCTV 2 talk show/investigative report “Is It True?” Joe has over 10 years experience in performing on talk shows in both the US and the China market and he was the first Asian to perform at the Radio and TV correspondents’ dinner. He also  won first place at the standup comedy competition at the Great American Comedy Festival.
  • Florian Fettweis. Florian is a China media expert with work experience in the US, Germany and China in TV and film production, distribution and media consulting. He is the Consulting Director for Beijing-based media consultancy CMM-I, he heads a small team to initiate, facilitate and execute cooperation between Chinese and Western media companies, with an emphasis on building global media brands into the fabric of the Chinese market.

For more information, please contact: Dana Lv, Tel: 010-8519 0864, Email: dlv@amchamchina.org.

Ben’s China Blog Is Back. Enjoy It While You Can.

Posted in China Business, China Travel, Recommended Reading
Ben's China Blog

If you were wondering, Ben is the tall White guy.

Way back in 2007, in a post entitled, Promising China Blog: Ben’s Blog Is Certainly “Cutting Edge,” we highlighted what was then called Ben’s Blog: A Midwesterner in the Middle Kingdom. At that point, Ben described himself and the purpose of his blog, as follows:

My name is Benjamin Ross and I am an American originally from Kansas City. I finished college in 2003 and came to China the following year. My reasons for coming to China were that I wanted to experience a lifestyle completely different from my cushy life in the “burbs.” I wanted to be shocked and isolated. I also wanted to learn a foreign language and actually have the chance to use it. For this reason, I did not want to go to a major city like Beijing or Shanghai. Rather, I found a job in Fuqing, a small town located in Fujian province in Southeastern China. For a year and a half I worked there as a University English teacher, until I moved to Fuzhou (the provincial capital in Summer of 2005. My current gig is doing ethnographic research for Pacific Ethnography.

I am also an amateur writer and photographer. Unless otherwise noted, all of the photography on this site was done by me. While in China I have also worked as an interpreter, TV extra, regular game-show contestant, and token white guy. Interesting (and often humorous) things happen in China all the time, so this blog is where I try to keep people up to date of what’s going on in my little corner of the Middle Kingdom.

What made Ben’s blog unique, however, was his foray into hair cutting (hence the incredibly witty title of my “cutting edge” post). Ben worked as a trainee at a local barbershop for less than $100 a month to get a better feel for China’s working class:

As an American living in China, I have spent the last three years of my life enjoying the benefits of being a citizen of a country which is far wealthier than the one in which I reside. I travel around town by taxi. I drink at expensive bars. I eat sushi. I take trips across the country, and when my apartment is dirty, I call a maid to clean it up. My life is not that different from the other several hundred Westerners who call Fuzhou home. We all come to China for the “China experience,” but we still live our lives with the advantages of being Westerners. But what is it like to be one of the 6 million Chinese residents of Fuzhou, especially those of the working class? For us China is fun and relaxing. It’s a place we come to expand our horizons, to learn a culture, to spend our copious free time studying Tai Chi and Chinese cooking or picking up girls at the bar. But for Fuzhou’s working class, there is no such fun and relaxation, no time for hobbies and no money for Tsingtaos at the pub. Work is a way of life and a means for survival.

Tomorrow I will begin a one-month stint as a ?? (trainee) at a local barber shop/salon. The manager will be treating me just like any other beginning employee his first days on the job. I will be starting at the very bottom of the barbershop food chain, and my duties will include sweeping hair, cleaning bathrooms, assisting barbers, and entertaining customers as they have their hair cut. Throughout the month I will have only three days off, and work the rest from 9 am to 8 pm. I will essentially be a slave to my job which for one month pays what I would make in one day of teaching English.

What I hope to gain from this experience is an understanding of what Chinese workers go through on a daily basis. What is it like to work a job 10 hours a day, 6 days a week, for a salary of less than $100 a month? How will this put into perspective my life in China as a foreigner, or my life in America as an American? How does the other half (or in this case 99.9%) live, and how do the respond to a foreigner trying to do the same? I hope to find the answers to these questions, and hopefully have a little fun doing it. I will be keeping my blog updated daily for the next month, so check back regularly for updates, and wish me luck. I’m going to need it.

I loved Ben’s blog back then because I loved Ben’s observations regarding the people with whom he worked and their industry. But Ben left China in August 2007 and eventually pursued a Ph.d in Sociology at the University of Chicago.

But for reasons of which I am not aware (and having just learned this from Facebook) Ben is back in China and blogging again about the business of hair in his inimitable style. The first post I read from his latest China trip is entitled Why has everything in China gotten more expensive…except for haircuts? and that post as well as anything that I have read anywhere encapsulates the brutal cost increases and competition that pretty much all companies — foreign and domestic — face when trying to do business in China. If you are interested in China from just about any perspective, including business, I urge you to start reading Ben Ross’s Blog (it’s current name). Take advantage of it while Ben is there as this is likely to be a limited time offer.

China Manufacturing Contracts: Made In China Doesn’t Have To Mean “Dangerous”

Posted in Basics of China Business Law, Legal News

We are constantly — both on this blog and in the real world — extolling the virtues of foreign companies having appropriate contracts with their Chinese manufacturers. Yesterday provided me with two instances highlighting that need. China Manufacturing Contracts

The first was an email from a company asking whether my firm’s China lawyers could assist them in seeking a refund of around $160,000 for bad product received from their Chinese manufacturer. The email on that is as follows, doctored a bit to hide any identifiers:

Our company designs and fabricates widgets out of Chicago.

At the end of 2014, we purchased a large qty of widgets (about x number for $160,000) from a company in Shenzhen.

We received a spec sheet for the widgets which I attach here. These specs match our standards and the CA compliance laws.

We cannot use the widgets that we received as they will not last and we are losing a lot of money and the delay in time is costing us  clients.

Can you please advise if you can help us? We would like to be repaid by the company that manufactured and sold us this product and also receive compensation for the money the additional production time has cost our company.

I look forward to hearing from you.

We responded as follows:

Thanks for contacting us.

Do you have a written contract with the Shenzhen company? Is your OEM contract in Chinese? Does it have the Chinese company’s seal on it? Does it provide for specific damages for failing to satisfy quality requirements? Does it provide for litigation in China and not the United States?

If you answered yes to all of the above, we can help you and we would be interested in doing so. If you answered no to any of the above, we would not be interested in pursuing this. For more information on what these contracts should look like, please go here, here, here, and here.

As is virtually always the case, the email we got back led us to decline the representation.

Only hours later, I was called by Everett Rosenfeld at CSNBC regarding Lumber Liquidators recent product problems. The article related to that interview is ‘Made in China’ doesn’t have to mean ‘dangerous.’ The article quotes me as follows:

“Probably 98 percent of the time when there is a product problem in China, a lot of the blame lies with the American company,” said Dan Harris an attorney who edits the China Law Blog.

Harris said he receives about five requests each week from Western companies asking for legal help on problems with Chinese suppliers. But his firm always turns down those requests because “they are usually not in a very good position to get compensated.”

The only way for companies to protect themselves, he said, is to ensure that they have written the right kinds of contracts beforehand. “If they have a really good contract with their supplier, then they should be in pretty good shape,” he said. “If not, then they could have a problem.”

The key to contracts, he said, is that they should “scare the heck out of a Chinese company” with very specific details about quality expectations, as well as minutia concerning subcontracts and repayment for bad products.

This is not quite right. I said that protection from China product problems rests on three legs: One, choosing the right partner. Two, having a China-specific contract. And, three, quality control monitoring. All three are important. Once you have a problem, the contract is the only thing that can save you, but to prevent the problem, all three are crucial.

Late last year we did a post entitled, Five Keys To Getting Good Quality Products From China, in which we briefly listed out the five keys to securing good product from China. That post follows:

Our China lawyers have assisted hundreds of Western companies with the legal side of having product manufactured in China. That experience has enabled us to see what works and what doesn’t for China manufacturing. If you want to greatly increase your odds of getting good quality manufactured product from China, you should do the following five things.

  • 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?
  • Use a Good OEM Agreement. Good contracts ensure that your Chinese company knows what is required of it and what will happen if it fails to provide it.
  • 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 Chinese. Be specific.
  • 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 wand and lets them know that you are serious about making sure you get it
  • 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.

In other words, good contracts are important, but so are other things. For more on this check out How To Prevent ‘Made In China’ Product Labels From Leading To Lawsuits Made In The U.S.A.

The CNBC article also quotes international arbitration attorney B. Ted Howes who says that “[G]enerally speaking, litigation in Chinese or U.S. courts is ineffective, Howes said. Chinese firms enjoy an advantage in their home-country courts. And any judgment in the United States is “essentially a worthless piece of paper” unless the manufacturer has American assets or has holdings in a third country that shares the right treaties with the United States. We agree that U.S. judgments are usually not worth the paper on which they are printed. In Enforcing China Court Judgments Overseas. Yeah It’s Possible, we made clear that U.S. court judgments are usually of no value against Chinese companies:

When it comes to enforcing US court judgments in China, the law has been clear and remains clear. China won’t do it. Not now. Not later. Maybe not ever.

Howes goes on to advise that “the most successful way for American firms to seek an award from a Chinese supplier is to enter into international arbitration—a process that requires the right provisions in a contract before any dispute arises.” On this we vehemently disagree. Chinese litigation is not great when pursuing Chinese companies, but neither is international arbitration. But putting a Chinese litigation provision in your manufacturing agreement is most of the time the absolute best way to avoid product problems.

To understand why this is the case, one must understand Chinese law and, most importantly, one must understand the role that contract damages plays in pursuing Chinese companies in litigation. In China Commercial Contracts: Writing the Contract Damage Provision,we explain contract damages and why they are so effective:

In our standard commercial contracts we often include a specific damage amount for certain (not all) violations of the contract terms. We work with our clients to ensure that such provisions are not a penalty, but rather an honest assessment of what real damages might result from the breach. This system has worked well in China and actually helps prevent litigation due to the certainty of result these contract damage provisions provide.

Common law lawyers often express concern about such contract damage provisions based on the general common law aversion to “liquidated damages.” This concern shows a lack of understanding of how the Chinese civil law system works in the realm of contact damages. The Chinese side will also often object. Their reason is clear: they understand the effectiveness of such provisions and they want to escape from this very real threat.

*      *      *      *

We also provide for contract damages because though China has no law/equity distinction (unlike common law countries), injunctive relief generally does not work well in China. We therefore want to have an agreed contract damage amount in cases where the actual amount of damages is difficult/impossible to calculate. In these cases where there is no clear monetary damage (the classic common law injunctive relief situation), the PRC courts generally have NOT allowed defendants to argue that no relief should be awarded. For this reason, though there is risk that the PRC court will reduce the contract damage amount, the risk is for a lower award. The risk is not that there will be no damage award at all or that the contract will be invalidated. Chinese courts very much prefer making a monetary award as an alternative to issuing an order (injunction) that they know they cannot enforce.

Mr. Howes falls into the common trap of Western lawyers: believing that the only reason for a good contract is to be able to sue on it and win. There are actually three main reasons for having a good contract and in countries with less developed legal systems, the other two rise in prominence. Those other two are to achieve clarity between the parties and to increase the odds of never having to sue.

In China Joint Ventures Are Back And Contracts Are The New In Thing. The New Reality Of China Foreign Investment and The New Role Of Written Contracts For Product Purchases In China, we wrote about how contracts with Chinese companies were increasing in importance and in value and we set out the following three key provisions for making your China contract effectively enforceable in China:

1. Enforcement is in China through litigation in the Chinese court system.

2. Governing law is Chinese law.

3. Governing language is Chinese language.

For more on what it takes to have a China contract that works, check out Using English-Language Contracts in China: My Q&A with China Law Blog.

Bottom Line: There are many things that American companies can and should do to help ensure good product from their Chinese manufacturers. The companies that engage in those “many things” greatly reduce their odds of having product problems.

Exporting From China By The Numbers: HTS (US)

Posted in China Business, Legal News

Companies deciding whether to export products from China must carefully weigh immediate and long-term profit potential against the costs of shipping and entering their products into foreign markets. The most important considerations are whether the laws of China and the foreign country allow the products to be traded and, if so, whether licenses must be obtained. Next, companies will need to know whether the products are subject to target country import duties and, if so, the amount of such duties. One of the necessary first steps to understanding these issues is classifying products under the export and target countries’ product coding systems based on the Harmonized System (“HS”).  Exporting Products From China

By way of background, the Harmonized Commodity Description and Coding System, referenced as the Harmonized System or “HS,” was developed by the World Customs Organization. The HS allows for standardized classification of goods to six digits. Over 200 countries use HS codes for different purposes, one of the most important of which is import tariff determinations.

For anyone who exports or will export products from China to the United States, such products must be classified under the U.S. Harmonized Tariff Schedule (“HTSUS”). One way to think about the HTSUS is to compare it to the Plinko game featured on the daytime television game show The Price Is Right. In the game, contestants drop chips onto a vertically sloped Plinko board and wait to see into which slot the chip falls, with different slots representing different amounts of money that the contestant may win. Like a Plinko chip that must fall into one of the board slots, a product imported into the United States must fit into one of the HTSUS classifications. Also, just as the Plinko chip’s fall determines how much cash a contestant will win, an HTSUS classification will determine whether an import duty applies to the product and, if so, how much.

The HTSUS is divided into different general sections, such as Section VII “Plastics and Articles Thereof; Rubber and Articles Thereof,” and 99 chapters, such as Chapter 39 of Section VII “Plastics and Articles Thereof.” Classifying goods under one of these HTSUS sections and chapters follows the General Rules of Interpretation detailed in the HTSUS. Though section and chapter headings may assist in determining the appropriate classification, exporters and importers must carefully review the terms of the headings and notes to determine correct classifications.

The General Rules govern how products are classified and provide a prioritized hierarchy for doing so. For example, the General Rules specifically state that references to products include unfinished versions of such products if the unfinished products share the finished product’s “essential character.” Similarly, the General Rules detail how to determine appropriate HTSUS classifications if goods can be classified under more than one category.

Regardless of where a product will be exported, exporters in China should undertake the necessary efforts and involve the appropriate company employees to determine a product’s HS classification. Classifying goods can quickly turn into a very technical exercise – especially when the goods at issue are electronic goods or contain many subcomponents or parts. Often, companies’ R&D or manufacturing departments need to be involved in the classification process to ensure products’ composition and uses are correctly understood.

Importantly, companies should dedicate the time and resources needed to correctly classify a product early in the process of evaluating export options.

Because import tariffs normally depend on assigned HS classifications, misclassifications can result in one of two unwelcome scenarios. Under one scenario, a company can incorrectly classify a product under an HS category that has a corresponding import duty that is higher than the HS category under which the product should have been categorized. Under a second scenario, a company can incorrectly classify a product in an HS category that has a lower import duty than the category into which it should have been categorized. As described below, both scenarios can have adverse consequences.

Under both scenarios, HS misclassifications can result in unnecessary costs and reputational damage. Unnecessarily paying higher import duties adversely impacts exports’ profitability and may even impact a company’s decision to enter an export market. On the other hand, failing to undertake the necessary due diligence to correctly classify a product under the HS can result in fines and penalties if an importing country’s Customs agency audits an HS determination. In addition to incurring Customs violations and penalties, importers can suffer reputational losses with the Customs agency that may result in future delays in importing goods in the future – yet another adverse indirect importing cost.

Companies that are doing business in China and looking to export their goods from China must carefully evaluate a target country’s legal system and import regime and the associated costs for importing into the particular country. Classifying a product under the HS – or HTSUS for the United States – is a fundamental requirement that will inform these decisions. However, care should be taken to ensure the HS classification numbers are correctly determined and documented at the outset. Second chances and revisions may prove costly.

 

 

 

 

 

 

China Contracts: Calling A Table A Chair Is Not Clever.

Posted in Basics of China Business Law, China Business
Cartoon by Paul Noth from the Conde Naste Store. http://bit.ly/18cKloW

Cartoon by Paul Noth from the Conde Naste Store. http://bit.ly/18cKloW

I like this cartoon because it is funny. But I love this cartoon because it is so China relevant. This cartoon was sent to me by my friend Roberto De Vido, whose  own very funny and topical cartoons can be found here. Roberto told me that “he knew” I would like this and then we discussed some of the examples we have seen where foreign companies actually tried similar things in China.

The reason this post is titled the way it is is because I oftentimes analogize to tables and chairs when explaining to clients why what they are proposing will not work. I tell them that we can call a table a chair, but it will still be a table, and vice-versa. I then tell them that no government — including the one in China — is going to treat a table as a chair just because you call it that, and the same holds true for contracts.

Over the years, our China lawyers have seen the following, among other things:

1. Contracts with Chinese employees who are working in China that claim to be contracts for the employee to work in the United States. US companies (and yes, US lawyers) say that they do these contracts so as to avoid China’s onerous tax and labor laws. I say that they do these contracts because they have absolutely no clue regarding either international law or China’s labor laws. First off, no country in the world is going to allow you to employ one of its citizens in that country and have some foreign law apply to that employer-employee relationship, notwithstanding any lie in your contract. Second off, if you do not have a written contract with your China-based employees, you are opening yourself up for massive penalties. If I were a Chinese employee, I would argue that a contract like this does not qualify and I would expect the Chinese arbiters to concur with that.

My all time favorite on this was when an American company contacted me after learning that the Chinese government had come by wanting to see their employment contracts. When I told him that he was in big trouble because the government would see that all of his contracts claimed that the employees were working in the United States, he asked me how they wouild be able to prove that. I pointed out that all they would need to do is check the employee passports. I am not making this up!!

2.  We often see royalty agreements, service agreements and product sales agreements intentionally mislabeled in an attempt to reduce taxes, avoid the foreign company from being deemed to be doing business in China, or to make it easier for the Chinese company to be able to get money out of China. This sort of thing is never a good idea.

3. We also have seen a number of times where companies have gotten into trouble with China customs for claiming to be importing X when actually importing Y. Companies typically do this to secure a lower duty or because the Y product requires certifications or is not allowed in China at all. Let’s just say that China customs is not at all understanding in these situations.

4. Bribes. Without naming names, one prominent company has had huge bribery problems both in China and elsewhere and one of the things this company allegedly did was to provide its employees with $5,000 in monthly “travel reimbursements” which reimbursements were actually for the paying of bribes. Not smart.

Roberto told me of a story involving a friend of his who had been convinced by his Chinese partner to describe its business to the Chinese government officials one way, when it was actually something else, and to do so in order to get a business license, even though its real business was not open to foreigners. Roberto said that at a certain point, the government official interrupts his friend’s “umpteenth explanation of why the business license should be granted” and says something along the lines of “Mr. Xxxxxx, we understand your business very well. And for that very reason we don’t want to grant you a license.”

It should go without saying — but it doesn’t — that lying is a always a very bad way to try to deal with a government and that your putting a false label on something not only does not usually work, but it also usually will subject you to additional penalties, including criminal. It should also go without saying — but again it doesn’t — that just because your Chinese counter-party insists that “everyone does it” does not mean that you will get away with it and that Chinese government officials did not just fall off the turnip truck.

The cartoon above is funny, but what will happen to you if you seek to emulate it will not be. You agree, right?