The other day, I spoke with a North American company that was seeking to get its tooling back from its former Chinese manufacturer.  This company’s domestic American lawyer had drafted a manufacturing contract with the Chinese manufacturer that was completely silent regarding ownership of the tooling/molds.  When the American company started getting bad product from its Chinese manufacturer, the American company requested the manufacturer return the tooling/molds.  The Chinese manufacturer claimed to own the tooling/molds.  The American company claimed that was not possible because it had the tooling/molds made by someone else and it had proof of payments that would prove this.

On top of this, the American company kept telling me that its lawyer insisted that it owned the tooling/molds.  He stopped saying this when I asked whether the lawyer claiming this was the same lawyer who had represented them when it contracted with the Chinese manufacturer.

I told the American company that it essentially had three choices.

  1. Get new tooling/molds made.  The American company told me that would take months and was unacceptable.
  2. Sue the Chinese manufacturer to try to get the tooling/molds back.  I said that would take months and since the American company did not have written and signed proof (preferably in Chinese) making clear that the tooling/molds belonged to it AND not to the Chinese manufacturer, I did not know who would prevail.  Either way, this would take many months. The American company told me that this was not acceptable.
  3. Try to negotiate a purchase price for the tooling/molds from the manufacturer, maybe at half their value.  The North American company let me know that having to buy its own tooling/molds back from its Chinese manufacturer was incredibly unpalatable, as compared to its other options, this was its best one.

What should the North American company (or more particularly, its lawyer) have done to prevent this horrible situation?  They should have explicitly (because if it isn’t explicit it pretty much doesn’t exist when it comes to China) put in their agreement with the Chinese manufacturer that the tooling/molds belonged to them and they should have explicitly put in the contract that the Chinese manufacturer would sustain liquidated damages of $10,000 for every day that it failed to return the tooling/molds. And they should have done this in Chinese and they should have gotten the contract sealed/chopped by the Chinese manufacturer.  This is what Chinese manufacturers understand and, more importantly, this is what Chinese courts understand and will enforce.  And because of this, as far as I know, we have never had a client whose tooling/molds have been held for ransom.

Early this evening, I listened to the last two minutes or so of a BBC radio show that seems to have been about a book writing anthropologist who writes about Papua New Guinea’s hundreds of tribes.  I got to hear him essentially sum up by saying that the tribes of Papua New Guinea deal with modernization/materialism one of the following three ways:

  1.  Seeking to reject it entirely and stick entirely to their old ways;
  2.  Seeking to integrate it into their existing ways, creating a synergy between the two:
  3.  Seeking to have it replace their ways, whole hog.

The North American company and its lawyer are not too dissimilar from the Papua New Guinea tribes that insist on sticking to the old ways no matter what they face.  Both essentially insist on going on with their lives as though nothing new had been introduced to them.

I received the following email this morning:

Your blog is interesting because it talks about project failures at the operational level. I bought couple of books you reviewed on your blog and the anecdotes of success they contain have been interesting and inspiring. Now, I am more interested in some material (in addition to your blog) that will provide insight on spotting major flaws in the operationalization of a project.

I’m in consumer research and I often tell clients how they should target a specific segment, what they need to do next. I have never been able to educate them on what NOT to do, and what major mistakes they need to look out for. That’s because I’ve never actually worked in their position (ie. actually executing a specific strategy).

It would be great if you write your own book or post more about failures. Case examples are much more insightful than ideological or CEO-level visionary “stuff”.

Seems this person realizes that China is different and that learning comes from this recognition.

The South China Morning Post recently ran an aptly entitled article by INSEAD Professor, Micheal WittBusinesses often fail overseas because the world is much less ‘global’ than they assume. The article is subtitled, “Key decision-makers often underestimate just how big, and important, global differences are.”

Its premise is that “many companies do not reach their full potential abroad” due to “incomplete preparations.”  It states that “surprisingly, many companies, even large multinationals, do not analyze the competitive landscape of the local [Chinese] market to determine whether it is possible to operate profitably.”  Foreign companies end up being surprised by the level of competition in China simply because they went into China without ever analyzing it.  Sort of like the North American company/lawyer who were surprised at losing their tooling/molds simply because they never even considered seeking to determine whether the rules on such things might be different in China than in North America.

The article notes the irony that “the tendency to fall for the fallacy that the world is indeed ‘flat’ increases with corporate seniority.”  Though the reason for this is “natural, as senior executives extrapolate from their own experiences within a confined international elite,” it also is “highly problematic, because it leads key strategic decision-makers to underestimate just how big the differences are. And as the international business literature has shown time and again, what kills companies abroad is their inability to handle these differences and deal effectively with the attendant ‘liability of foreignness.'”

It goes on to discuss how institutional variations occur between countries and at “the most fundamental level, they show themselves in what a society accepts as the legitimate purpose of doing business.”  Western business schools generally teach that firms exist to maximize shareholder value, but the writer’s

But according to Professor Witt’s research, few societies and senior managers outside the Anglo-Saxon world accept this view:

To simplify very crudely, Hong Kong firms exist to produce family wealth; German firms, to produce needed goods and services for society; Japanese firms, to provide benefits to their employees; and South Korean firms, to keep highly conflictual demands by controlling families and hostile stakeholders in balance.

Few companies ever pause to consider these issues and their implications when expanding abroad. Many an international partnership was, foreseeably, doomed from the beginning because fundamental objectives did not match.

Do you think about such things?  I do all the time.  I mean, why do some companies seem to just coast into China while others stumble in and never recover?  What more should we be writing about to help those seeking to do business in China or to sell to China?  For what it is worth, I would say that the knowledge North American companies looking at doing business in China is both considerably higher today than it was even five years ago and considerably higher than the knowledge Chinese companies have about doing business in North America.  Do you agree on that?

I am in the process of writing an article for a leading publication on the things I am seeing that tell me China’s economy is cooling. The statistics from China seem to be saying everything is just fine, but man, all I can tell you is that my firm has been absolutely inundated with matters that tell me we are in the throes of a crash.

The email I just received has become unbelievably typical over the last few months:

Hi. I am an avid reader of China Law Blog. I run a small _________ company in Shanghai and have come upon my own situation in which I would like to ask for a legal opinion. It’s not a very big issue and maybe not even worth pursuing it but since we are a very small company with limited funds it’s still of relevance for us.

A part of our business is renting out _________ machines to customers such as restaurants. One of these restaurants has just gone out of business. Since several months of rent are due to the landlord, the landlord has locked the shop down with all equipment (our _______ machine, the restaurant’s employees’ personal things, etc.) all still inside. The landlord is saying that they will release everything inside the restaurant only after discussing with the restaurant operators, all significant employees of which have now left town.

I am not exactly sure what will happen, the situation is vague as many things are here, but we would like to get our machine back (wholesale cost of about 20k RMB).

My questions now are if the landlord has the right to keep our property (e.g. the machine) and if not, if there is anything worthwhile that we can do about it?

Thank you.

Here is my response:

Without reviewing your contract with this restaurant, I have no way of knowing what you can and should do. If you have a really good contract (preferably in Chinese) that makes clear that the ______ machines belong to you unless and until they are fully paid-for, then you should show that to the landlord and odds are good he will let you walk off with your machines. If you don’t have such a contract, I wish you good luck because at that point it is not likely to be very clear who owns what.

We have lately been getting a ton of these sorts of requests and I am going to do a blog post on it, stripping your email of any identifiers. 

This is China’s new reality, brought about by the fact that businesses are failing and foreigners are now much more intwined in China’s economy than ever before.  We are right now working on the following matters, all of which I am being intentionally vague about for obvious reasons:

  • Chinese manufacturer gets shut down because it has fallen behind on its loan(s) from the government/private company/private individual. Foreign company has X dollars worth of product sitting in this factory. In some cases, the foreign company has paid for the product, but lacks a good contract to prove that it has paid in full for it and the lender is seeking more before it will release it. In other cases, the foreign company has yet to pay anything for the product but it needs it really badly because it has already sold much of it on to others, with an incoming delivery date. 
  • Chinese manufacturer gets shut down because it has fallen behind on its loan(s) from the government/private company/private individual. Foreign companies molds/tooling are in the factory and it wants those back so it can quickly and cheaply move on to having some other Chinese manufacturer make its product. The lender is saying that the molds/toolings now belong to them. We have previously written on what you can do to protect your molds in China and that advice holds doubly true for the situation when someone else has come in and taken over the factory of your Chinese supplier. For those How Not To Lose Your Molds In China.   Want Your China-Based Molds? You’re Probably Too Late For That How To Protect Your Molds And Tooling In China.

The contract really is the key. In most cases, there typically will be some negotiating with the landlord or lender, with the key to that negotiation being your leverage and your leverage will depend on the quality of your contract. If your contract makes clear that the asset belongs to you, the lender/landlord typically will choose to give you your asset. If your contract is less than clear on this point or if you have no contract at all, it typically becomes a negotiation between you and the landlord/lender and you will need to pay about as much for the assets as the landlord/lender thinks it can get by selling the assets to someone else.

Every few months we get a frantic call from someone wanting our “immediate” help in getting them their molds back. These situations usually present themselves as follows:

Small to mid-sized company (“SME”) has spent $25,000 to $250,000 building a mold(s) for manufacturing their product in China. SME provided this mold to its one Chinese supplier so that their Chinese supplier can make product for the SME. The Chinese supplier provided bad product to the SME and now there is a dispute between the SME and the Chinese supplier and the SME wants its mold(s) back right away so that it can move on to a new supplier, without their being any interuption in product supply.

The SME wants us to sue “right away” in China to get their mold(s) back.

I then ask to see the SME’s written contract with their Chinese supplier and then I tell them how difficult their case will be because of their contract, or lack thereof. 

Without going into too much detail, the bottom line is that if you want to have a good chance of getting your molds back quickly, you need to lay the groundwork for this in your written and sealed. For more on this, check out “How To Write A Chinese Contract That Works.” That contract must state very clearly that the molds belong to you and it must set out very clearly the molds to which it is referring. If you do not do this, the Chinese manufacturer will (just about every time) claim that its deal with you involved them taking over ownership of the molds.

This contract should be in Chinese and it should also very clearly set out the damages the manufacturer will be required to pay you if it fails to promptly (which will also be defined in the contract) returned.  These provisions are called liquidated damages provisions and to find out more on why they are so critical to Chinese manufacturing contracts, check out “China Manufacturing Agreements. Make Liquidated Damages Your Friend.

If you want to read more on Original Equipment Manufacturing (OEM) Agreements and on what they should be comprised, check out the following:

Bottom Line: Plan for getting your China-based molds back before you need them back.

A couple days ago, we did a post, entitled, Your Mold Done Gone To China And It Ain’t Never Coming Back, stressing how those doing China OEM Agreements need good contracts to protect their production molds and tooling. Earlier today, we did a post, entitled, China Consultant: Protect Thyself, focusing on how China consultants without good contracts with their clients are setting themselves up for legal problems.

I never expected to be proven so right. So soon. And certainly not in the same lawsuit.

The Bowling Green (Kentucky) Daily News just ran a story, entitled, Holley in Midst of Legal Struggle Over China Deal, that goes a long way in proving the importance of having good contracts when doing business in China, particularly when that business involves molds or consultants.

According to the article, about two years ago, Holley Performance Products began securing materials from China. Holley’s website describes itself as “the undisputed leader in fuel systems for over 100 years. Holley carburetors power every NASCAR team and every NHRA Pro’Stock champion. The Holley line also includes performance fuel pumps, fuel injection, intake manifolds, cylinder heads & engine dress’up products for street performance, race and marine applications.”

Seems that in February of this year, Holley was sued by Doug Smith, “an Ohio-based consultant who helped the company [Holley] secure a supplier in China.” Smith sued Holley for allegedly circumventing Smith by “using his supplier in China without his authorization.” Smith claims to be “on the losing end of the deal after spending more than 185 days in China helping Holley.”

Apparently angered about the alleged circumvention by Holley (see our consultant post to avoid this happening to you), Smith decided to”repossess” Holley’s tooling.  Holley did not take too kindly to Smith’s actions and sued for the return of its tooling:

‘In my last trip to China, I went to all the suppliers and repossessed their tooling,’ Smith said. ‘We had a counterproposal on the table on a Thursday night, but by Friday morning, I had a FedEx package on my front porch with a lawsuit to get their tooling back that they didn’t pay for.’

On November 9, 2006, United States District Court Judge Joseph McKinley issued an injunction ordering Smith return the tooling:

‘The judge gave them a temporary restraining order to give the tools back that Holley hasn’t paid for,’ Smith said. ‘And they’re trying to put me in jail right now. It’s absolutely amazing, they’re trying to put me out of business. It’s like legal stealing.’

Attorney Todd Olhms, who represents Holley, said that Judge McKinley issued a contempt order against Smith for not returning the equipment. The judgment ordered Smith pay Holley $10,000 per day until Smith complies with the court’s order to return the equipment.

Oh, and one more bit of advice for consultants and EVERYONE else: when a Federal Court judge issues an order requiring you to do something, you do it, and you do it even if you do not really want to do it and even if you do not think it is fair. Failing to obey a court order constitutes contempt of court and, as Mr. Smith has learned, the penalties for that can be quite severe.