If you import a product into the United States from China, the odds are good that your competitors can find out about it. And by find out about it, I mean they can easily and very cheaply (sometimes even for nothing) use a service such as Import Genius, Panjiva or Tradesparq or others to determine what you are importing, how much of it you are importing, and even who you are using to manufacture it.

Don’t want your competitors to know from where you are buying your distinctive xyz product? You had better do something to hide it.

But what? The following methods are commonly employed to hide import information:

  • Set up your own Hong Kong entity and have that company buy the product from your China manufacturers and then be the shipper. Doing this means that the name of the Chinese manufacturer will not be easy for your competitors to discover, but it will not hide the quantity and the nature of your US imports.
  • Have your Bills of Lading made out to your customs broker in the United States. That way, US customs shows your customs broker as the importer and your name stays out of it.  The flaw in this though is that if your competitors know through which ports you are importing, they can maybe figure out who is importing your product (your customs broker) and then work backwards to figure out your manufacturer.
  • Have your bills of Lading made out to your freight forwarder both in China (as the exporter) and in the United Sates (as the importer).  Doing this hides both your manufacturer’s name and your name from your competitors.
  • Set up a “dummy” company in the United States for importing of your product. This has the same potential flaw as using your customs broker to receive your product; it does not hide the name of your Chinese manufacturer.

What are you doing out there to protect your manufacturing trade secrets?

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?

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?

Our clients often ask that we put a provision into their manufacturing agreements prohibiting their Chinese manufacturer from making the same product for anyone else. This naturally leads to a long discussion, that often goes somewhat like the following, using a laptop computer bag as the example:

China Lawyer:  What do you mean by a product like yours?  A laptop bag?

Client: That would be great. Is that possible?

China Lawyer:  Not unless you are planning to commit to buying $800 million worth of bags a year. Your Chinese manufacturer probably makes laptop bags for 40-50 other companies and unless you commit to massive yearly volumes, there is no way it is going to just make bags for you. What we need to do is figure out what makes your laptop bags different from everyone else’s laptop bags and see if we can get your manufacturer to agree not to make laptop bags for others that contain your unique features.

Client:  That makes sense. Well, first off, our name is unique and I certainly don’t want our Chinese manufacturer making bags with our name on it for anyone but us.

China Lawyer: Absolutely. We will put that in there, but also, we are going to need to register your brand name as a trademark in China so that nobody in China (not just your manufacturer) can make bags with your name on it. We also need to register your trademark in China to prevent anyone else from registering your name and then being able to stop you from using your own name  at all in China. What else distinguishes your bags from others?

Client: We use orange stitching and I don’t think anyone else does that.

China Lawyer:  Great, so we ask that this manufacturer not make bags with orange stitching. What else?

Client:  We have a side pocket that perfectly holds a passport. What about something like that? Oh, and we have an orange rubber tab on all of our zippers.

China Lawyer:  Perfect. We will put a provision into your OEM Agreement that prohibits your Chinese manufacturer from making laptop bags with any of this attributes.

Client: Are these provisions enforced?

China Lawyer:  Yes, in both China and the United States.

Client:  The United States?

China Lawyers. Yes, the United States. If one of your US competitors were to go to your Chinese factory and start purchasing laptop bags with stitching or zippers or a side pocket like yours, we would immediately send them a letter, attaching your OEM contract with your Chinese manufacturer. That letter would point out the provision saying that your manufacturer is not allowed to make laptop bags with your specific attributes and then it would say that your competitor’s getting such laptop bags from your Chinese manufacturer constitutes tortious interference with your contractual relation. We would then say that if they do not immediately cease buying such bags, we will have no choice but to sue. These letters generally work because the US company either did not know it was infringing on your contract rights or else because it simply does not want to be sued in a US court, even if it may think it will eventually prevail. These provisions tend to be very effective.

Many years ago, a company that manufactured outdoor products that it sold in hardware stores across America came to us with the following problem:

Its Chinese manufacturer had (through a straw person) registered in China about a dozen trademarks that our new client used on its outdoor products.  More importantly, the Chinese manufacturer had just informed our new client that it would no longer be manufacturing these outdoor products for our client because it was now going to be selling them directly to the same hardware stores to which our client had been selling the products.

WRONG.

The Chinese company never sold even one single product to anyone in the United States and in the end it lost tens of millions of dollars a year in revenue by having so unceremoniously cut-off our client.  The Chinese company failed to sell any products to US hardware stores because it had zero clue what it takes to sell its products in the United States.  The Chinese company went to the various hardware stores in the United States that had been selling “its” products and told them that it would now be able to sell them the exact same products for around 50% less.  But when the US hardware store chains asked the Chinese company about the systems it had in place to make sure that each and every one of its stores would always have the right number of outdoor products in stock (i.e., what inventorying system it would be using) the Chinese company had no real reply.  And when the US hardware store chains asked the Chinese manufacturer how it would handle product repairs and returns it had no answer for that either.

We worked with our client and figured out how to get around the Chinese trademarks the Chinese manufacturer had filed. To make a long story short, it had failed to trademark all of any one product and we were able to secure China trademark registrations for parts of the whole and it was on those parts that our client prominently put its trade name, after registering those trade names in China.

I thought of that Chinese outdoor products manufacturer today when I read a ZDNet article entitled, Big CES push from Chinese phonemakers, but tough sell in US. The gist of the article is that China is making excellent cellphones and smart phones these days but it has yet to sell anything but a handful of its phones in the United States and the big reason for much the same reasons why the Chinese outdoor products manufacturer failed to sell its own branded products:

“It’s one thing to have the product. It’s another thing to have all the relationships, build the distribution channels and do the marketing,” Frank Gillett, an analyst with Forrester Research, told the newswire. A partnership is particularly important in the U.S. where the majority of users buy heavily subsidized devices through carriers.

I have seen this same sort of thing in other industries in the United States where my law firm has represented Chinese companies unwilling to do what it takes to sell their China branded products in the United States.  These companies have been unwilling to spend the kind of money required to market or distribute their products in the United States and, perhaps most importantly, they have been unwilling to hire top-tier people in the United States who know how to market to US consumers.  I have heard countless similar stories from other service companies that work with Chinese companies trying to mark into the US market.

Succeeding at selling consumer products (really most products) in the United States virtually always requires more than just having the lowest price.  Unless and until Chinese companies truly understand this (rather than paying it mere lip service), the threat of Chinese companies taking over the US consumer market is minimal at best.

Just saying….

What do you think?

 

It’s the weekend, which means that I watch the Seattle Seahawks annihilate an opponent (the Tennessee Titans are this week’s victim) while cleaning up my inbox.

In my inbox was an email from one of our China attorneys to a client for whom we are working on an NNN Agreement, but who will likely eventually need a product development agreement and an OEM Agreement, along with China trademark protection.  It does such a good job of setting out the contracts that are usually needed for foreign companies seeking to manufacture in China that I thought it would be helpful to our readers to post on it, so here goes:

Attached please find an English-language draft of an NNN Agreement, as well as an accompanying Acknowledgment of Receipt (to track exactly which information has been shared with the Chinese party, and when).

In your responses to the NNN questionnaire, you note that you will be sending Chinese companies a sample of the product that you want manufactured (i.e., ________), for the sole purpose of determining whether the Chinese entity can make it. This is exactly the situation in which one ought to use an NNN agreement. That said, your responses also anticipate the possibility of having the Chinese company create custom machinery, and also discuss various details regarding the production of your _______ product. These things are not suited for an NNN agreement.

For the sake of clarity, the appropriate way to handle manufacturing in China of unique products is to have three agreements. First, an NNN Agreement, for the situation in which you reveal confidential information about the product to determine, conceptually, if the Chinese party can make the product(s). This is your current stage. Second, a development agreement, to cover the cost/procedure/ownership of rights of product development, and to figure out if the Chinese party can in fact make the product you want at a sufficiently high level of quality, in a suitable timeframe and at an acceptable cost. Third, an OEM contract, to cover the manufacturing and purchase of the product(s). Many vendors (and buyers) want to cram all of the above into one agreement, promising that they can of course manufacture what you want, and any product development will be folded into the contract. It’s an awkward fit. A manufacturing agreement is not a development agreement.

It sounds like you might need at least one more contract, depending on the answers you get from the Chinese manufacturer. It also sounds like you ought to file at least one trademark in China. We can discuss all of this later. For now, please review the attached and let me know your thoughts.

For more on the legal basics of having your product manufactured in China and the China manufacturing agreements that typically go with that, check out Getting Started On Manufacturing In China. The Legal Basics.

David Dayton over at the Silk Road International Blog did an excellent post on China manufacturing a couple years ago, but I just saw it today. The post is entitled, “What to ask for at a trade-show (and afterwards too),” and it starts off with Dayton saying that he is writing the post because he is always getting asked what to look at for at trade-shows.  The post is full of excellent advice, some of which I highlight below.

Dayton starts by listing “First questions” to ask of manufacturers you meet at a trade-show and are considering using.  A select portion of those questions are below, along with my comments in italics:

  • Where is the facility and can you go to visit (this week while you’re in the country)?  Visiting the facility may be the single best thing you can do to determine whether you are going to be dealing with a high quality Chinese manufacturer and, on top of that, I am convinced that just visiting increases your chances of being taken seriously by your manufacturer, which in turn, increases your chances of getting good product.  
  • Do they have business documents that they’ll let you see?  I am not sure exactly to what business documents Dayton is referring, but generally it is a good idea to, at minimum, make sure that the company you are dealing with is actually registered in China and is truly the same company that makes your product.  It also never hurts to see documents showing that your potential manufacturer has done this before. American companies tend to be reluctant to ask for this sort of thing, but you should know that Chinese companies are not.  Just asking for these documents will separate you out from many others and thereby earn you increased respect, which definitely can impact product quality. 
  • Will they let you talk with engineers and other managers?  If they will not allow this, you should be suspicious. 
  • Will they allow 3PQ?  If they will not, you should be suspicious.
  • Can they give you referrals?  Note that Chinese manufacturers sometimes refuse this request for valid reasons.
  • Can you meet and even QC sub-suppliers?  If your Chinese manufacturer is going to keep the identities of its sub-suppliers a secret, your odds of quality control problems just went up. 
  • How do they deal with non-conforming product?  Not sure if I agree with this one as we are of the view that our clients should be telling the Chinese manufacturer how to deal with non-conforming product.  Generally, we seek a refund of any amounts paid, along with the destruction of all of the non-conforming product.  

Dayton goes on to point out that even once you have found a “great factory,” you still have to determine whether it is a good fit for you.  He proposes asking the following excellent questions to find out:

  1. What is their average order qty?  Is your order similar?
  2. What is their average order time?  Is your lead time sufficient?
  3. Have they done similar projects (similar levels of customization, similar components)?
  4. Can you communicate with them effectively and do you feel comfortable working with them?

Lastly, Dayton lists out what Western companies need to do on “their end of the deal”:

  1. Always keep you word concerning dates and monies and anything else that is your responsibility.  Check.  
  2. Always take into account the reality that if you’re late with art (or money or answers) it will cause production delays (usually longer than your delay).  Check
  3. There will be problems, so take notes and keep records and follow up on anything that you’re not clear on.  Check.
  4. NEVER MAKE ANY ASSUMPTIONS.  Double-check.  For more on this, check out China Legal Issues For Business. The Ten Minute Version.
  5. Never make any changes to your specs or to your contract.  I disagree with this one, so long as the changes are handled appropriately.  
  6. File all legal work in your home country and in China BEFORE you start passing out specs to anyone (even at the show).  I think what David is saying here is that you need to make sure that all your intellectual property protections are in place BEFORE you start flashing around your IP.  For more on this, check out Register Your China Trademark Now. Then Register It Again With Customs.
  7. Spec out all your details and present them in a consistent and clear format.  Check.
  8. Meet FACE TO FACE with your factory as much as possible.  Check.
  9. Admit when problems are your fault and take responsibility for them.  Check.
  10. There will always be problems—usually you can work through them.   But always find a back up facility just in case.  Check
David’s post has many more tips for those looking to manufacture product in China and for those already manufacturing product in China and if you fit either of those two categories, I strongly urge you to check it out.
What do you think?

We are always telling our clients that they cannot be too specific with their product requirements when buying product (OEM product or otherwise) from a Chinese manufacturer.  Words like “blue” or “good quality” or “typical in the industry” are meaningless.  There is a wide range of blues and unless you specify the exact blue that you want, your expectation the odds that you will get the one you want or even the one in the sample are incredibly slim.  And what does “good quality” mean in a country where you can buy t-shirts for 25 cents that will fall apart after one wash?  Typical in the industry?  What industry and how do you expect some manufacturer in China to have any clue about safety or fashion or anything else in the United States.

No, what you need to do is set out exactly what you want.  If your product and all of your competitor’s products are always made with 10% copper and everyone knows this, you still make  VERY CLEAR in your spec sheet that you want your product to be made with 10% copper and then in the contract itself you make VERY CLEAR exactly what liquidated damages you will be entitled to if the product has anything less than 10% copper in it.

When I talk on what should go into Chinese contracts, I usually relay something like the following:

Many years ago, I heard a story of an American who was renting an apartment in Shanghai. Now I am not even sure if this story is true or apocryphal, but it is such a good story to illustrate how Chinese judges and arbitrators view contracts it really doesn’t matter whether it happened or not.

It was a nice apartment, that this American was renting, and it had a really nice expensive office chair (high end apartments in China are virtually always rented out fully furnished). One day, the really nice office chair broke and became unusable and the American tenant kept asking his Chinese landlord to replace it. But that wasn’t happening.

The lease on the apartment eventually came up for renewal and the American refused to renew it unless the landlord put in writing that he would replace the really nice office chair. The landlord agreed and after the new lease was signed, he came by and put in a $2 metal folding chair.

What would happen in the United States if this tenant were to sue the landlord over the landlord’s failure to replace the office chair with something pretty comparable? Anyone know?

The tenant would win because the court would essentially write into the lease contract the provision that the replacement chair had to be a good office chair like the one it was replacing. What would happen if the tenant sued the landlord in a Chinese court?

The Landlord would win because if you want something in your contract in China, you had better put it in there.

Why is this chair story even relevant? It’s relevant because American companies time and time again fail to put enough into their contracts with Chinese companies. Instead, they just assume the courts or arbitrators will know what the parties intended and re-write their contracts accordingly. But it doesn’t work that way in China.

We had a company come to us after having received a large shipment of laptop bags that weren’t strong enough to hold a laptop. We called the Chinese company to ask about getting a refund and they told us that if our client had wanted a bag strong enough to hold a laptop, it should have paid 50 cents more per bag for one that could actually do that. This company should have specified in its contract that it wanted a bag that could hold x number of kilograms.

I was reminded of all this today after reading a post by Renaud Anjoran on his always excellent Quality Inspection blog.  Renaud’s post is entitled, “Be ULTRA SPECIFIC with your Chinese Suppliers” and, needless to say, that is the advice it conveys.  What’s cool about his post though is that he shows a couple of examples where Chinese companies (his own hotel) are super specific in conveying their messages.  This got me to thinking that the need to be super specific may stem from China’s hierarchical society and the role each person sees for him or herself.  To grossly summarize, we Americans love to claim to “think outside the box” whereas in China thinking inside the box is oftentimes valued more highly.  Then again, it all just may have to do with how US courts are so willing to infer contractual terms and Chinese courts are not.

But the reason for having to be ultra-specific in your Chinese contract is not what matters; what matters is that you do so because that is THE key in how to get good product from China and to a certain extent, one of the keys to doing business in China or with China.

For more on what should go into your China OEM Agreement and how to succeed in outsourcing product from China, check out the following:

What do you think?

One of the themes we have been addressing for the last year or so is how the relationship between foreign companies and their Chinese product suppliers is maturing. A few months ago, in The New Role Of Written Contracts For Product Purchases In China we wrote of how rising product prices have increased the need for good contracts between foreign companies and their China product supplier and of how such contracts are becoming far more common.

There is an old saying that “good contracts make good partners” and that is even more true in a cross-cultural context, as we noted in China Contracts Make Sense:

A contract is the best way to make sure that you and the Chinese company with which you are contracting are on the same page. For example, if you ask your Chinese supplier if it can get you your product in 30 days, it will say “yes” almost every time. But if you then put in your contract that the Chinese company must pay you a penalty if it fails to ship your product within 30 days, there is a very good chance the Chinese company will tell you that 30 days is impossible. At that point, you and the Chinese company should figure out realistic shipment dates and put that in the contract. You then know what is actually realistic to expect by way of shipment dates and you can act accordingly with your own customers. Spending the time to negotiate a contract with your Chinese counter-party, especially if that contract is in Chinese is the best way I know to achieve clarity before you lock yourself into a relationship.

With this increase in contracts between foreign companies and their Chinese product suppliers has come an increase in what I would describe as good relations between these two sides. Though I do not ascribe the increased use of contracts as the sole factor in the rising level of the supplier-purchaser relationship, I do see that as a factor.  But whatever is causing it, I am convinced it is happening because I am more and more hearing from foreign companies that rightly describe their relationship with their Chinese manufacturer as a partnership.  Foreign companies are becoming more experienced at dealing with Chinese factories and Chinese factories are becoming more experienced at dealing with foreign companies.

And with these real partnerships comes a desire from both the Chinese manufacturer and the foreign product buyer to “take the business to a higher level.”  This desire typically manifests itself with the two companies wanting to sell their “mutual” product in China (and sometimes elsewhere in Asia) together or to develop new and better products together. Neither of these things are particularly legally complicated but both of these things call for new contracts.

If you are going to have your Chinese manufacturer selling your product in China, you should, at minimum, enter into a distribution and/or licensing contract with your Chinese manufacturer. Your manufacturing agreement is not going to cover even close to the various important matters that are involved with using another party to market and sell your product.

For what is involved in a distribution contract with a Chinese company, check out the following:

If someone else is going to be using your trade name or logo in China or elsewhere, either through a distribution or a licensing arrangement, you are almost certainly going to want to register that trade name/logo as a trademark to make sure you and nobody else have ownership of those trademark rights. Here’s some information on that: China: Do Just One Thing. Trademarks.

If you are going to work extensively with a Chinese manufacturer to develop a new product, you need a specific product development agreement. These agreements cover the cost and procedure for development and ownership of the developed product. Many companies fail to enter into this kind of agreement and then discover that the Chinese side owns “their” product and/or molds at the end of the process.

What are you seeing out there?

Renaud Anjoran over at the Quality Inspection Tips blog recently wrote on “How your Chinese suppliers might become your competitors.”  Anjoran provides some excellent suggestions for preventing your China supplier from competing with you, based on his notes from a talk by Paul Melkebeke, Vice President Supply Asia for Samsonite.

Melkebeke talked of how building a brand and a distribution network is a long-term investment.  No doubt about that.

He then noted how Samsonite protects its IP by all available means — patents, design registrations, copyrights, Non Disclosure Agreements (NDA), etc, but these things are “not enough.”  I completely agree.  Companies must do everything they can to protect their IP from China and from elsewhere and doing this requires more than just registrations and contracts, as we noted in our post, How To Protect Your IP From China. Part 2:

Though there are, of course, particular protections you can and should employ depending on what you are doing in China, it will almost always make sense for you do to do the following four things.

  • Do business with the right people in China. Companies with nothing to lose are far more likely to take your IP than those with established businesses and reputations and incentives for not getting sued.
  • Think about what you have that needs protecting. What do you have that others want? What do you have that your competitors would love to get their hands on? Is it your technology?  Your customers?  Your brand?
  • Figure out how you (not your lawyer) can protect what needs protecting. Can you break into subparts whatever it is that you want to protect so that nobody in China gets access to the full thing? Can you get away with sending an older version to China? Can you lock it down in your building in China or on one computer such that your employees cannot leave with it? Can you keep the key portions on a server in the US?  These sorts of protections are usually called structural protections and they can be absolutely critical.

Melkebeke noted how Samsonite helps its suppliers improve on efficiency and quality, knowing that the supplier’s other customers (Samsonite’s competitors) will also benefit from these efforts. This is a really important issue and one that is difficult to address. One way to handle this is to become the exclusive buyer from your supplier. But if you are not Wal-Mart, the odds of your being able to achieve that are incredibly slim.  We have had clients that have purchased equipment for their Chinese suppliers with the proviso that equipment can be used only to make our client’s product. This too is pretty rare though.

Melkebeke noted how “many suppliers compare their FOB price to Samsonite’s retail price, and think it is all profit. Many of them start their own brand and push for distribution. But retail space is not cheap in China, and these companies are not expert at this game, so they end up losing money. So far, none has been successful.”  This is something we often discuss with our manufacturing clients that outsource product to China, especially when they claim that “there is no chance our Chinese manufacturer will ever be able to compete with us.” I often give the following example:

We had an outdoor equipment manufacturer (“USA Company”) come to us after its Chinese manufacturer (“China Manufacturer”) had stopped making outdoor equipment for USA Company. China Manufacturer had not only stopped making outdoor equipment for USA Company, but it had also registered USA Company’s brand name as a China trademark in over a dozen different categories/classes (this was before China prohibited this sort of thing by agents).  China Manufacturer’s plans were to sell the outdoor equipment to the two large hardware store chains to whom USA Company had been making the overwhelming bulk of its sales.

China Manufacturer completely struck out in its efforts to sell its own products to the two large hardware store chains. China Manufacturer went to those chains and offered to sell its product for about half the price of what USA Company had been selling them, but both hardware chains basically threw it out because China Manufacturer had no plans and no ability to maintain constant stocking of the products and no plans and no ability to repair the products and no plan and no ability to handle returns and other customer service needs. China Manufacturer’s plans to sell directly into the US market were essentially a joke.

Nonetheless, China Manufacturer had done huge harm to USA Company’s business.  USA Company had to scramble to find a new supplier (it succeeded) and it also had to figure out how to get its products manufactured and shipped out of China without violating China Manufacturer’s trademarks (it did, by securing a trademark for small engines and then prominently plastering its name on the small engines of all of its outdoor products).

The moral of the above story is that you cannot count on your Chinese manufacturer not trying to compete with you even if doing so makes no sense at all.

Melkebeke went on to note how the internet has broken down selling barriers and OEM manufacturers can sell their products online, but only at “a very low price” and “this is not the way to build a brand.”  China is Samsonite’s second largest market after the US. According to Melkebeke, Chinese consumers are willing to pay a premium price for Samsonite product and are “as picky as Japanese consumers.”  Because of this, despite helping its manufacturers improve, Samsonite is not really hurt by suppliers that try to compete with Samsonite because Samsonite prevails because of its quality and brand recognition.  But, Melkebeke rightly notes that companies with a weak brand, and in certain categories (e.g., electronics, where components and specifications are easily compared) are at much higher risk of losing business to a China supplier that seeks to compete with them.  I completely agree.

Anjoran then wrote about how Melkebeke advocated for employing legal methods to keep suppliers in their place, “even if they are not 100% effective.”

The first comment to Anjoran’s post stated that “legal contracts are next to useless in most cases unless you are a Samsonite or an Apple. For SMEs, the only sustainable strategy is relentless innovation.”  I completely disagree.  

From the legal side, there is a lot that can be done to protect yourself from your China supplier, even though, like anything else, these things will not work 100% of the time.  But really, legal protections are probably more important for small and mid-sized companies than for a massive company like Apple!

Let me explain.

First, I would urge everyone to read a post we did last week, entitled, The New Role Of Written Contracts For Product Purchases In China, in which we talked about how the importance of having real contracts with Chinese suppliers has increased and of how American companies are reacting to that:

This approach is changing and more and more foreign buyers are entering into long-term purchase contracts with their suppliers (typically called OEM Agreements, Manufacturing Agreements, Product Supply Agreements, or Product Sourcing Agreements). There are several reasons for this trend.  Probably the most important reason is the drive for standardization on the part of buyers. Chinese product is just one part of a worldwide supply chain. Major retailers have diverse sources of product. All product has to meet a basic standard to fit smoothly into the chain.  Product that is delivered late or that does not meet specifications fouls up the chain. Product that is subject to an intellectual property infringement challenge or that contains pirated, non-standard parts or that contains a non-standard component that raises safety issues disrupts the supply chain.

In the early days of buying product from China, the price was so cheap that these non-compliance issues and their resulting costs were simply absorbed by the foreign buyers at each stage of the purchase chain. However, in the current environment of tight supply chain management, the disruption is normally quite costly and cannot be tolerated by retailers already financially stressed by the current economic environment. As a result, retailers are imposing strict standards on their direct suppliers. The strictness of the controls and the magnitude of potential losses mean that foreign buyers can no longer simply absorb the costs of non-conformance by the Chinese manufacturers.

Foreign buyers now have no choice but to impose the same standards on their Chinese suppliers. Thus foreign buyers must enter into written contracts for product purchases from their Chinese suppliers that mirror their own obligations to their major retailer customers. These contracts must be supplemented with detailed supplier manuals and codes of conduct that seek to regulate the day-to-day business operations of the Chinese manufacturers.

None of this is unusual in North America and Europe, but the approach is very new to most Chinese export oriented manufacturers. The purpose of these agreements is quite simple. The purpose is not to make the situation better but rather to impose liability for non-performance directly on the Chinese manufacturer. That is, the foreign buyer is saying: “I no longer will simply absorb the costs caused by your lack of compliance with the conditions of sale. If you (Chinese manufacturer) do not perform, I will suffer a loss and I am going to pass that loss on to you.”

Second, check out our post from 2011, entitled, Getting Started On Manufacturing In China. The Legal Basics.  In that post we set out the legal basics for manufacturing product in China, in the form of a response to a typical email from a US company seeking to have its products manufactured in China:
The first two things you will likely need are a Non Disclosure Agreement (NDA) and a registered trademark in China. We prefer to do what we call an NNN Agreement — non-disclosure, non-use and non-circumvention. This is an agreement that you use when you are trying to find manufacturers for a product. You have the manufacturer sign the agreement before you show them the product. It prevents manufacturers from stealing your design for themselves and from going around you to sell the product to your US customers.

Here is some more information on NDAs/NNNs:

If you are not concerned about manufacturers in China copying your designs, you do not need an NDA/NNN Agreement.

The one thing you will almost certainly need to do (but maybe not right away) is to register your trademark in China. Before you use any of your trade names (think brands or product names) or trademarks in China (think logos), you absolutely must register them in China or someone else almost certainly will and then you will not be able to use your name in China, even if all you are doing is exporting your product from China. Here’s some info on that: China: Do Just One Thing. Trademarks.

Depending on your situation, you may also want/need a Product Development Agreement. If you are going to work extensively with a Chinese manufacturer to develop a new product, you need a specific product development agreement. These agreements cover the cost and procedure for development and ownership of the developed product. Many companies fail to enter into this kind of agreement and then discover the Chinese side owns “their” product and/or molds at the end of the process.

Once you have chosen the manufacturer for your widget, the next thing you will need is a Manufacturing Agreement (these are also called supplier agreements and OEM Agreements). Many US companies do all their manufacturing in China based on purchase orders. This is very bad for the US side. A good manufacturing agreement covers IP, quality control, NNN issues, warranty, ownership of molds, tooling, supplies, diversion, dispute resolution, and all the other various issues that arise in a manufacturing relationship.

Here is some more information on Manufacturing Agreements:

But what is a small company to do?  The above.  But what about the idea that contracts are “useless” for small companies?  I am not sure why this commenter said this, but I do know that small companies often ask me whether it is worth having a contract if they cannot afford to sue to enforce it.  I often respond by saying that if they cannot afford to sue on a breached contract, they also cannot afford bad product and that is all the more reason they need a contract.  There are many reasons to have a good contract with your Chinese supplier and suing on a breach is but one of them.

As anyone who has been involved in litigation anywhere in the world will tell you, it is a horrible thing. It is expensive, time consuming, and imperfect. Litigation signifies the end of discussion between parties and, as such, it should only be undertaken after all other avenues have been exhausted. As I am constantly telling clients, “if you have to sue, you have already lost. You can win the litigation, but even so, you will have lost.”

Litigation virtually never brings anyone a complete remedy.  If you are owed $250,000 and you sue and the court awards you $250,000 and the other side pays you in fairly prompt order, you still have not achieved a complete remedy.  What about the time you spent trying to settle the case before suing? What about what you might have done with the $250,000 had you received it sooner? What about your attorneys’ fees in dealing with the problem? What about all the time you and your employees had to spend on the case?  Litigation is not a complete remedy, which just underscores point number 1 on how it should always be a last resort.

There is huge value in having a contract with your Chinese counterpart that has little to nothing to do with winning a lawsuit. Even if you never intend to sue anyone in China, it makes sense to have a good contract, preferably in Chinese.  There are three main reasons to have a good contract, and suing and winning on it is only one of them.

One of the main reasons for having a good contract with your Chinese product supplier is to make sure that the two of you are on the same page. We wrote about this reason in Chinese Manufacturing. Delivery Date? What Delivery Date?:

One of the most common problems we see between American companies and their Chinese manufacturers is “late” delivery.  I put late in quotes because many times I think the problem is not so much that the Chinese manufacturer was late, but rather that the contract and the American buyer were unclear on the actual delivery date requirements.

Let me explain.

When we draft an OEM Agreement (a/k/a Manufacturing Agreement or Supplier Agreement), we are always very careful regarding delivery times.  Most of the time, our clients come to us with a term sheet or an oral agreement with their Chinese manufacturer dictating something like 30 days for delivery.  We like strictly tying the Chinese manufacturer to the “agreed-upon” delivery time and we usually do that with a liquidated damages provision tied to late delivery.  Just by way of example, we might put into the OEM Agreement a provision saying something along the lines of delivery shall be within 30 days and for every day beyond thirty the Chinese manufacturer shall be required to pay US Company 1% of the purchase order price within ten days.

Perhaps more than any other contract provision, we tend to get blow-back on the delivery time provision from the Chinese manufacturer. Oftentimes when faced with the reality of having to pay a set amount for late delivery, the Chinese manufacturer gets really serious about delivery times and tells us that they simply cannot promise delivery within the previously “agreed” time frame.  Our client usually realizes it is better to get real agreement (even if longer than originally anticipated) before ordering, rather than getting late delivery after ordering.

The other, somewhat related issue we face on delivery times is that when our client comes to us and says it has agreed with its Chinese manufacturer to a 30 day delivery schedule, we then have to figure out 30 days from what.  We typically go with 30 days from the issuance of the purchase order, but oftentimes the Chinese company pushes for it to be 30 days from its receipt of payment or 30 days from its receiving proof of payment.

Bottom Line:  Certainty is important with respect to delivery dates and, without a doubt, the best way to achieve that certainty is a written contract, in Chinese (so that there is no doubt the manufacturer understands what is on the paper) clearing setting forth the delivery date.

In my view though, the main reason to have a good contract is to prevent problems on which you might need to sue:  We wrote about this way back in 2006, in China OEM the Smart Way:

The best solution for this is to prevent it from happening in the first place and the best way to do that is to choose the right supplier and use a good OEM contract.  When we draft OEM contracts for our clients, we always put in a provision precluding the Chinese manufacturer from subcontracting out production. Without exception, the Chinese manufacturers have agreed to this provision and, again without exception (at least as far as we know), they have always abided by it.  The reason for this is simple.  The manufacturer may have twenty some companies for whom it produces goods, but probably less than half of them forbid subcontracting.  When the Chinese manufacturer is so busy as to require subcontracting, it makes sense for it to first subcontract out work for those foreign companies for whom it is NOT prohibited by contract from doing so.  I am always analogizing this to bike locks.  Even the best bike lock cannot prevent all thefts, but its efficacy comes from the fact that bike thieves generally find it easier to steal a bike with a poor quality lock or none at all than one that is difficult to break.

Any contract that makes your Chinese counter-party think twice about messing with you has at least some value.  My law firm has settled a number of matters with Chinese companies based on well-written contracts, but we decline to take on cases without contracts.  Having a well written contract does not mean you will always win your lawsuit if you are forced to sue on it. But it does mean you will have some leverage if things go wrong and it does mean you will at least have a chance. Having no contract means no chance.

How do you stop your Chinese supplier from becoming your competitor?

  1. Choose the right Chinese supplier.  A company that is thriving has a lot more to lose than one that is tanking.
  2. Register your intellectual property (trademarks, copyrights and patents).
  3. Make sure your supplier signs well-written (preferably in Chinese) contracts that forbid it from competing with you or improperly using your IP.

It is that simple.

What do you think?