Archives: China lawyers

It used to be rare for one of our clients to be unable to secure a desired trademark in China because someone had beaten them to it. With the proliferation of trademark filings in China over the last 3-5 years, those halcyon days are over.

When our pre-application screening turns up a conflict with a previously registered trademark, we often suggest that our client determine whether the preexisting trademark has been abandoned. Under Chinese trademark law, failing to use a China trademark in commerce at least once every three years puts the trademark at risk of cancellation. I use the words “at risk” because in China a trademark is presumptively valid throughout its term unless someone files a non-use cancellation against it (or otherwise challenges its validity). Of late, our China lawyers have been fielding a lot of inquiries regarding non-use cancellations.

Before we file a non-use cancellation, we gather up our own evidence regarding non-use, usually using Baidu for the initial search. If something shows up on Baidu indicating that the trademark has in fact been used recently, our work is done and securing a non-use cancellation will likely not be possible. If we do not find anything on Baidu, we generally expand our search until we either find evidence of trademark usage or become convinced that filing a non-use cancellation is the way to go.

Filing a non-use cancellation in China is fast and easy, but as with everything involving the Chinese Trademark Office these days, the rest of the process is often delayed. The good news is that with most of our non-use cancellations, the trademark owner never responds and, once the CTMO processes the filing, the “offending” trademark is cancelled, clearing the way for our client’s application.

Our China lawyers often review leases for companies early in the WFOE registration process. Our work in this area has been growing exponentially as word has gotten around regarding WFOE registrations increasingly going awry and landlord problems stemming from WFOE leases.

The pendency of a WFOE formation is a complicated time for a commercial lease because of issues surrounding who the tenant on the lease should be. Should it be the foreign company that will be owning the WFOE or should it be the not yet formed WFOE?

Most of the time when we are called in to review these leases, the line on the lease where the tenant’s name should go has been left blank. The company that retains us has no idea what company to list as the tenant and so they hire us to help. Choosing the tenant is a significant issue and — as is typical for so much else in China — different cities require different procedures.

The following two approaches are typically followed in China for the tenant of a WFOE to be:

  • Specify the U.S. (or other foreign country) parent company as the tenant on the lease. If this is done, it is important that the tenant be the company that will be the parent company of the WFOE (and not some other entity). The lease should also specifically provide that when the WFOE is actually formed, the landlord will allow the lease to be assigned to the WFOE at no cost. Some landlords will require a time limit, some do not care. Failing to put this into the lease upfront can lead to the landlord charging an exorbitant amount to allow the assignment, which assignment you will need to get your WFOE registered.
  • Specify the WFOE as the tenant. You cannot use this method unless a name for the WFOE has already been approved. Under this approach, the landlord normally will require a time limit for the formation of the WFOE. Various remedies are proposed for dealing with the situation where the WFOE is never formed. This is a very awkward method, since a non-existent entity is being specified as the tenant. However, recently the Shanghai government has begun insisting that this method be used. Again, it is critical that your method complies with local requirements.

Determining how to proceed regarding the named tenant requires input from the local government authorities who will approve the WFOE. If your lease does not handle the lessee issue properly, the government generally will not approve your WFOE and/or you will end up having to incur all sorts of additional landlord and contracting costs.

If the U.S. (or other foreign country) company is listed as the tenant, the U.S. company will be required to pay the rent and the security deposit and other fees. Since the U.S. company is not a Chinese company, it will be required to pay these fees in U.S. dollars and that creates the following issues, among others:

  • The landlord must be willing to accept payment of initial rent and deposit in U.S. dollars.
  • The management company must be willing to accept payment of its management fees in U.S. dollars.
  • The utility companies must be willing to accept payment of their fees in U.S. dollars.

All of this can be quite complex and in many Chinese cities, the utility companies simply will not accept dollar payments. Many landlords will also refuse to accept U.S. dollar payments.

It is also important that the lease for a potential WFOE address the issues arising from WFOE formation. Our China lawyers typically draft a lease addendum that addresses the following:

  • The landlord acknowledges that the lease will be used for legal address for a WFOE.
  •  The landlord warrants that the leased premises is legally suited for use as a WFOE address.
  • The landlord agrees to cooperate with all documentation and procedures required for use of the lease in the WFOE formation process.
  • The landlord agrees to register the lease as required and to provide tax receipts for all rental payments. If there is a problem with the premises in terms of zoning or payment of fees, the government will refuse to register.
  • The landlord agrees to provide proof of ownership of the premises before execution of the lease.
  • The landlord agrees that if the lease is rejected by the government in connection with the WFOE formation process, the lease will terminate and the landlord will refund all payments made up to the date of termination.

Many landlords — particularly smaller landlords and landlords in cities with little foreign direct investment — will refuse to execute such an addendum. When that is the case, our job as lawyers is to discuss the costs and benefits of increased due diligence and the various risks involved in moving forward, or not.

 

With the costs and the hassles of forming and operating a WFOE in China always increasing, we are finding more of our clients are choosing to retain personnel in China via third party staffing agencies. Doing so is relatively easy and relatively inexpensive, assuming you can find a third party staffing agency willing to do the hiring.

When one of our clients has decided to go the third party staffing route, we write them an email along the lines of that below.

The way to proceed with hiring your quality control inspectors through a staffing agency is as follows:

  • Inform your QC inspectors that you will soon be getting them employed through a staffing agency, both to let them know and to find out if they have any particular issues with your doing things this way.
  • Find a staffing agency to help with this. Our lawyers in China have contacts at two of the larger agencies and we would be happy to make introductions.
  • Once you settle on a staffing agency, the staffing agency will prepare two sets of agreements: one between your company and the staffing agency, and one between the staffing agency and each of the QC inspectors.
  • I recommend that you have one of our China lawyers review and revise both sets of agreements. Generally speaking, the staffing agencies use boilerplate agreements that contain mistakes and inconsistencies.
  • If the QC inspectors will be privy to trade secrets or other confidential information, I recommend that you have us draft separate individual confidentiality agreements between the QC inspectors and your company. Although the staffing agency agreements usually contain confidentiality provisions, such provisions are almost always inadequate.
  • It is also important to have these inspectors sign off on your company rules and regulations, including especially those relating to ant-bribery and kickbacks. It also usually makes sense to draft provisions relating to more mundane things like hours, work locations and methods of supervision and communication, since there is no set office procedure for this kind of “employee.

See….

 

China allows for non-compete agreements that prohibit high level employees from working for another company that competes with the employer. However, these agreements are generally limited to senior management, senior technicians and other personnel who have a confidentiality obligation to the company. In exchange for the employee’s promise to maintain the non-compete requirement, the employer is required to pay economic compensation to the employee. After an employee has left his or her company, the company oftentimes would prefer not to continue paying the employee and thereby bring an early end to the non-compete agreement.

Pursuant to the Judicial Interpretation IV of the Supreme People’s Court on Several Issues Concerning the Application of Law in Hearing Labor Dispute Cases (“Judicial Interpretation IV”), employers that unilaterally terminate a non-compete agreement during the non-compete period must pay the employee with the non-compete agreement three additional months’ salary for the early termination. In other words, employers cannot just walk away from their previously signed non-compete agreements without a penalty. Our China lawyers frequently see non-compete agreements that purportedly allow the employer to unilaterally terminate the agreement by giving one month’s notice to the employee. As explained above, this runs afoul of Judicial Interpretation IV.

Note though that some labor bureaus refuse to comment on the application of judicial interpretations. Some (like Shanghai) say they still refer to the PRC Labor Contract Law as their guideline. The Shanghai Labor Bureau is of the view that neither party can unilaterally terminate a non-compete agreement during the non-compete period. The Shanghai authorities base their position on the basic contract law principle that agreements generally require mutual consent to be terminated. The Labor Contract Law does not address this issue. As with the compensation required for an employee non-compete agreement, even though Judicial Interpretation IV is supposed to supersede all the local rules, it is nonetheless advisable to check with the relevant authorities to figure out the applicable rule is as we are still seeing quite a lot of local differences.

Judicial Interpretation IV provides no guidance on how employers can terminate a non-compete agreement during the employment term (i.e., before the non-compete period begins). Some practitioners believe that given the pro-employee approach of Judicial Interpretation IV, it is likely that an arbitrator or court would mandate that the employer pay three months’ compensation. On the other hand, it could be argued that because terminating a non-compete agreement releases the employee’s non-compete obligation even before the non-compete period has begun, the employer should not be obligated to make any payment because the employee never performed his or her obligation not to compete.

Note also that Judicial Interpretation IV gives employees the right to unilaterally terminate a non-compete agreement, provided the following conditions have been met:

(1)   The employee has performed his or her non-compete obligation;

(2)  The employer has failed to make compensation payments for three months or longer;

(3)   The failure to pay the employee was caused by the employer itself. In other words, the employee cannot prevent the employer from making payment so to avoid the employee from having to perform his or her obligations.

Bottom Line: Once the non-compete period has begun, employers cannot terminate a non-compete agreement without being subjected to a penalty. Since it is unclear whether this also holds true for an employer terminating a non-compete agreement during the employment term, we recommend inserting a provision into your non-compete agreement or employee contract making contractually clear exactly what will happen with an early termination of your non-compete agreements.

 

 

 

We started a China Law Blog Group on Linkedin with the goal of creating a spam-free source for China networking, information and discussion. We now have nearly 8,500 members and, more importantly, a number of lively discussions.

We have had some absolutely terrific discussions, both based on the numbers (a number of the discussions have received around 100 comments and some have gone over 200) and on their substance. Our discussions have ranged from practical (such as, how do I open a China bank account or what are the best practices for a China Joint Venture or what is the most important thing to do for doing business in China) to deep think (such as, what is the future of rule of law in China? or what are the differences in how Chinese companies and French companies are run).

What also boosts the group is its diversity of membership. We have a large contingent of members within China and without. Some members are China lawyers, but the overwhelming majority are not. We have senior personnel (both China attorneys and executives) from both large and small companies and a whole host of junior personnel as well. We have students and we have professors. This mix only contributes to the high level of discussions.

I am most proud of how (at least as far as I know) no spam item has yet lasted on the site for anything even approaching 24 hours.

If you want to learn more about China law or business, if you want to discuss China law or business, or if you want to network with others doing China law or business, I suggest you check out our China Law Blog Group on Linkedin and join up. The more people in our group, the better the discussions.

We will see you there. Click here and join us.

One of our China lawyers got an email the other day from an American company that just learned it is in trouble here in the United States (yes, I am being deliberately vague here) stemming from having imported and sold a whole slew of electronics products that are listed as UL certified, but are not. The US company designed the product and sold it under its own brand name. They wanted help finding a new manufacturer that would actually secure UL approval for their products, and not use bogus certificates falsely claiming approval.

Our suggestion to them was that they themselves work with UL to secure any necessary approvals, as that would greatly increase the chances of any approval (or even disapproval) being legitimate. The American company initially mildly complained about having to pay for the UL approval themselves, but quieted rather quickly when I pointed out the following two things:

1.  It had probably never had to pay for any UL testing with its previous manufacturer or only paid a fraction of the real cost. I am guessing that the Chinese manufacturer got the project by underbidding based on its plan to forge UL certification.

2.  If the Chinese manufacturer does pay for UL testing and certification it will both need to charge more for the product (which in turn means that the American company ends up paying for it in any event) and it will — unless there is a clear agreement to the contrary — be the one that holds the UL certification, making it more difficult/expensive for the American company to switch to another manufacturer at some future point.

What do you think?

Every so often one of our China lawyers will get an email from someone who essentially challenges us to tell them why they should hire us. Our response is to patiently explain why they are wrong to think that they do not need a lawyer and to not so patiently tell them that it would probably not be a good idea for us to represent them. We do this because we long ago learned that taking on a bad client is never a good idea and that trying to convince someone to hire you who believes that do not need to do so never works out.

I got such an email the other day from an American company that seemed downright angry that one of our clients “had insisted” that they contact us:

________ at ________ [our client company] insisted that I contact you about our China manufacturing plans even though I have been doing business with China for more than twenty years.  ______ tells me that you believe that contracts with China manufacturers can be worthwhile but I know that it is the government there that determines everything. I want to stop my Chinese manufacturers from copying my products and selling them to my competitors. I doubt any contract can do this for me but can you lay out for me exactly how your company can help me, how long it will take and what you will charge. They just signed the attached NDA but ________ keeps telling me that I should have you modify it. If you are going to do that, I will need it back by the end of the week.  I also am enclosing a manufacturing agreement my lawyer drafted for me and I would appreciate your point of view as to how realistic it is.  We made it very favorable for my company.  It is approximately 10,000 words and so I also need to know what you will charge to revise it. I need this back by the end of the week as well.

Here was my response:

I hesitate to spend time on this because I do not think that you will retain us both because you have come to us too late for us to fix your NDA (which, quite frankly, does not achieve what you want it to achieve) and because you are neither going to believe nor like what I have to say. So I instead urge you to read  How To Stop Your Chinese Supplier From Becoming Your Competitor and China Contracts. Why Even Bother? and all of the links contained in these.

What you have done so far is unlikely to help you in dealing with Chinese manufacturers. It just does not sound like you have received good advice so far and I have to wonder whether that is because you have been hiring the wrong China attorneys (or no attorneys at all) or if it is because you are not interested in changing how you do business with China.

An American NDA with jurisdiction in Chicago is not likely to have any impact on a Chinese company. What you need is not really a China NDA at all, but an NNN (Non-Disclosure, Non-Use, Non-Circumvention) Agreement that protects you before you have actually chosen a particular manufacturer for your product.  This sort of agreement can go a long way towards preventing potential or future manufacturers from stealing your design.

The ability to sue in Chicago is not likely to give you any power over a Chinese manufacturer. The bottom line is that Chinese manufacturers do not fear foreign litigation as much as they fear being hauled into a Chinese court and hit with liquidated damages (or even worse, a pre-judgment seizure of their assets). The goal with our NNN agreements (and of all our China contracts) is to prevent the Chinese company from doing what you don’t want them to do, not so much to beat them if you end up having to sue.

There is no point in our using your existing NDA as a template because it would take us more time to do that than for us to use our own template and then modify that to suit your current needs. More importantly, non-disclosure isn’t really the risk you face; it’s non compete that really matters and your NDA is completely silent on that. Your biggest risk isn’t your Chinese manufacturer disclosing your product to someone else; your biggest risk is your Chinese manufacturer making your product.

I spent five minutes reviewing your manufacturing agreement and that was enough time for me to determine that too also isn’t close to what you need for China. Honestly, it isn’t close for what you would need in the United States either. It does not mention any penalties for bad quality nor does it set forth any sort of timeline. These two things are the most basic provisions one expects to see in such an agreement. It reads as though a non-lawyer cobbled it together from various contracts on the internet. You probably would be better off with no contract at all.

And there is no way that we can promise you anything by the end of the week because we do not even have a good idea yet of exactly what it is you really need. You are going to need to determine whether you are prepared to spend money to do things right in China contractually or just continue muddling through. You know what I would recommend, but of course it is entirely up to you.

I never heard from him again.

The title is stolen from the Warren Buffett line, “You can’t make a good deal with a bad guy, regardless of any piece of paper. And it is so true.

Our China lawyers are always telling our clients the following:

  • Legitimate Chinese companies do not want to get sued. In our experience, they are even more concerned about getting sued than are American companies. They do not want to get sued because getting sued is both expensive and damaging to their reputation.
  • Crooked Chinese companies do not mind getting sued, because they can always just shut down and they have little to no reputation to protect.
  • The above means that a good contract with a good company can be very valuable at making sure the Chinese company does what you want it to do.
  • A great contract with a crooked Chinese company has virtually no value at all, because the crooked Chinese company does not much care.
  • The above means that you must be careful about with whom you do business in China (or anywhere for that matter).  Do your due diligence before you contract.

There are three primary reasons for having a good contract with your Chinese counter-party.

1.  Clarity. The first is to achieve clarity. To make sure you and the Chinese company are on the same page. For example, if you ask your Chinese supplier if it can get you your product in 20 days, it will say “mei wenti,” or not a problem, pretty much every time. But if you put in your contract that the product must ship in 20 days AND for every day it is late, the Chinese company must pay you 5% of the value of the order, there is a great chance the Chinese company will get honest with you and tell you that 20 days is impossible. At that point, you and the Chinese company can figure out a more realistic time frame and then you know what to realistically expect going forward. Needless to say, we can give countless examples of this sort of thing, but this is yet another reason why our China attorneys advocate putting your contract in Chinese. Clarity before you start the relationship is critical.

2.  StrictureThe second benefit of having a well written Chinese language contract with your Chinese counter-party is that the Chinese company knows exactly what it must do to comply. And, in most cases, it might as well. Let’s use the 20 day example as the example here too. If your Chinese manufacturer makes widgets for 25 foreign companies and five of those foreign companies have very clear time deadlines with a very clear liquidated damages provision in their contracts, and the Chinese company starts falling behind on production, to which companies will the Chinese manufacturer give production priority? Of course it will put the five companies with a good contract at the front of the line. Why wouldn’t it?

3.  Enforceability. My firm has written hundreds and hundreds of China contracts and we have never once been called on to litigate any of them nor are we aware of any of them having been litigated. We attribute this to reasons #1 and #2 above, and this just reinforces our claim that good contracts help prevent problems. It also bears mentioning that the World Bank ranks China 19th among 189 countries at enforcing contracts.

What do you think?

Despite the increasing restrictions on using employee dispatch companies for hiring of “your” China employees, our China lawyers have seen very little by way of a slowdown in smaller companies choosing to go that route, especially if doing so will allow them to delay having to form a China WFOE that much longer.

The legal issues for foreign companies that use employee dispatch companies are not terribly complicated, with one exception.

The way the whole system works is that you as the foreign company sign a contract with the employee dispatch company for it to hire as its own employee an individual or individuals you would like doing work for your company. The better dispatch companies generally have pretty good contracts for this and so our role as attorneys for our foreign clients is mostly to point out the provisions at which our clients have some negotiating power.

The complication arises in the contract between the employee dispatch company and its/your employee and it is here where we see the most mistakes being made. The employee dispatch company drafts its employment contract with its/your employee to protect and benefit itself, without any real regard for you.  In most respects, your interests are fairly well lined up with the employee dispatch company and so for the most part it is a good thing that most of these companies draft good China employee contracts.

But when it comes to your intellectual property, you need to account for the fact that your employee dispatch company does not care at all. And when I say, “at all,” I mean at all. Your employee dispatch company does not care if its contract with its/your employee protects your IP and your employee dispatch company does not care if its contract fails to protect your IP.

For this reason, you have to care and you have to be the one to make sure that the employee contract reflects this. If you want to be sure that the employee does not end up owning your intellectual property, you need to make sure that the employee contract is clear on this. If you want to be sure that your employee signs a contract that reduces the likelihood of he or she running off with your trade secrets, you need to make sure that the employee contract has provisions for that.

Cause if you do not make sure that your China attorneys do this, nobody else will.

Many months ago, I was in on an email exchange between a couple of our China lawyers regarding a liquidated damages provision in a product development agreement where our client was paying a Chinese manufacturer a lot of money to develop a new product that could be taken into production. Our biggest concern with the product development arrangement was that the Chinese manufacturer would sell the product to others after our client paid the large sum of money to have it developed.  So we wrote the contract to prohibit that and to give that provision added force we put in a liquidated damages provision listing out exactly how much our client would be entitled to in damages were the Chinese manufacturer to violate the non-compete provision forbidding them from making the product for anyone else.
Wikipedia nicely defines liquidated damages as follows:
Liquidated damages (also referred to as liquidated and ascertained damages) are damages whose amount the parties designate during the formation of a contract for the injured party to collect as compensation upon a specific breach (e.g., late performance).

We really like liquidated damages provisions in our China contracts because Chinese courts tend to view contractual liquidated damages provisions very favorably and so long as they are not unreasonable, they will usually be enforced. Most importantly, courts will seize Chinese company assets based on a liquidated damages provision and they will seize these assets before trial. Chinese companies know and fear this. A well-crafted China contract with a well-crafted liquidated damages provision is one of the best tools out there for preventing your Chinese counter-party from breaching your agreement, and that is the primary reason for having a contract in the first place.

In this particular product development contract, we put in a high number for the liquidated damages provision and the Chinese side immediately accepted it. This led co-blogger Steve Dickinson to write the following email:

Yes, _________  [our client] asked for a high number and I put it in at their request. Interestingly, the Chinese side signed with no complaint and with no objection from their Chinese attorneys either. I think that Chinese companies that do not plan to default simply don’t have a problem with contract damage numbers in this kind of agreement. The companies that complain are to be viewed with caution.

In terms of contract damages, it is important to be clear. As with the US, the number is not intended as a penalty. It is intended as an honest effort by the parties to predict damages in advance. If the number is too low, the injured party can ask for more. If the number is too high, the defendant can ask for a reduction. In either case, the validity of the contract itself is not affected.  The advantage of liquidated damages is that it gives you a sum certain when you go to the court to ask for preliminary relief such as seizure of assets. As long as a court is involved, the Chinese companies know that prejudgment asset seizure based on the amount of contract damages is a real risk and this makes them much more compliant in dealing with these issues. Where arbitration is involved, liquidated damages has far less utility, which is yet another reason why international lawyers should not be so quick to jump for having China contract disputes resolved via arbitration.
For more on the effectiveness of liquidated damages provisions in China contracts, check out the following: