Non Disclosure Agreements

We recently did a set of tooling agreements for a client doing business in China and as a part of that, one of our China lawyers sent the client the following instructions on making sure those agreements were properly signed:

As noted above, you must ensure that the tooling agreements are properly executed by the Chinese companies that will control the tooling. This means that you need to make sure that each of these agreements is signed by a duly formed Chinese company and by the legal representative of these Chinese companies, and that the names and addresses of the Chinese companies are in accord with the information registered for those companies and that the formal company chops are used to seal the agreements. […]

In terms of verification of the Chinese company information, at minimum you need to do the following: 1) personally visit each factory; 2) obtain the business card of each person who will sign on behalf of each Chinese company and have that person give you a specimen of their company’s chop; 3) obtain a copy of a previously executed company document to verify the authenticity of the chop; 4) obtain a copy of the business license which will provide the registered address and the name of the legal representative. If ANYTHING about the tooling agreement is inconsistent with the information you receive, DO NOT EXECUTE it and do not do business with the manufacturer. Even a simple mistake in the address can lead to invalidity of the contract

A few months later, another of our China lawyers did some China NNN Agreements (a/k/a NDAs or Non Disclosure Agreements) for the same client.  NNN Agreements are not long or complicated agreements and they are typically discussed and even entered before the parties have a much of a business relationship. Our client asked our (and its) lawyer whether it would need to go through the same long and somewhat difficult process for the signing of each NNN Agreement, just as it had done for its tooling agreements.

Our lawyer responded as follows:

The short answer is that the same standard of enforceability applies to all China business contracts.
I understand your concern that the legal representative of the Chinese party may not always be willing to sign your agreement. It is always preferable (and safer) to have the legal representative sign, but if the agreement is sealed with the company chop then it should still be enforceable even if it is signed by some other company representative.
With regard to the verification steps listed, none of them are, strictly speaking, mandatory. That is, they do not themselves make a contract any more enforceable. But they are all highly advisable. The more steps you take, the more confident you can be that the contract has been properly executed by the proper company. Of these steps, securing the business license of the Chinese company is probably the most important, for two reasons: (1) it provides an easy method of verifying the name and registered address of the company and the identity of the legal representative, and (2) it is extremely easy for the Chinese party to provide, and if they can’t do so it is usually a warning sign.
It is that “easy.”

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?

A potential client recently sent me a contract written in both Chinese and in English. The English portions were silent about the controlling language but the Chinese portion made crystal clear that the Chinese language portion would control.  And guess what? The Chinese language portion was very different from the English language portion. So different, in fact, that the American company that sent me the contract had no claim under the Chinese language portion, yet it would have had a claim under the English language portion.  My firm always rejects this sort of case because we just assume that the Chinese court will look only to the Chinese language portion of the contract.

This taking advantage of what looks like a dual language contract is a very old trick, and one I have seen at least a dozen times, and not just with China/Chinese.  But for the trick to work, the non-English speaking party has to assume that the foreign language in its contract (in this particular case, Chinese) is the same as the English and never even bother to get it translated.  The foreign party is betting on ignorance/laziness/cheapness/naiveté.  Unfortunately, that is too often a good bet.

I also have on two recent occasions received poorly drafted “Non Disclosure Agreements” (NDAs) from potential clients who want to use those agreements to sue their manufacturer for copying their product and stealing their customers. In both cases, I have had to write the following email:

Near as I can tell, your “NDA” does not help you one bit. It says that your Chinese manufacturer cannot disclose confidential information to any third party, but it does not say a thing about it stealing your designs or competing with you.  In fact, it makes clear that it is free to do whatever it wants with whatever is in the public domain and it will no doubt argue that your __________[product] is in the public domain. I also note that the manufacturer did not chop/seal this document so there is also a good chance that it may not even be binding on it and an even better chance that it will at least make that claim.

It is possible that you can bring a trade secret/unfair competition (or some other non-contractual) claim against your manufacturer, but in many ways, your existing contract may hurt you in pursuing even those claims. If you want to sue this company I suggest you seek to retain Chinese counsel to do so, but I suspect that you will have difficulty finding a good firm that will take this case on a contingency basis.
Whatever you do in terms of your present problem, you should get a new contract in place for any new China orders. That new contract should, among other things, state clearly that your manufacturer cannot use your designs or copy your products or solicit your customers.
Sorry I cannot be more encouraging on this.
Before anyone accuses me of writing this post to try to convince those who are doing business with China to retain a qualified and Mandarin-fluent lawyer to assist them with their China contracts, let me say that I plead guilty. I have said it before and I will say it again. Nearly all of the contracts we see that were drafted without such assistance are of little to no value to the foreign party.  I know that is strong language, but it is also the truth.
What are you seeing out there?

Probably more than any other agreement, there is a conception out there that it is just fine to use an off the shelf NDA Agreement when dealing with China.


At least as much as with any other sort of agreement, it is critical to tailor your NNN Agreement (we call our NDA Agreements NNN Agreements because they include non-use and non-compete provisions, in addition to non-disclosure provisions) to your specific situation. I thought of that this morning as I watched a number of emails fly back and forth between a couple of my firm’s China lawyers regarding a couple of NNN Agreements we are in the process of drafting.

Together, these two emails do a great job of showing how you need more than just an “off the shelf NDA” and of exactly what typically goes into drafting an NNN Agreement that will be effective for each individual company.

The first email was sent to client A at the commencement of work on its NNN Agreement:

I will be drafting your NNN agreement for China. For the start, please provide me with a one or two paragraph description of what you will be doing in China for which you are seeking protection by this NNN agreement. Note that what what we mean by an NNN agreement is: 1) Non-disclosure, 2) non-use and 3) non-circumvention. For China, 2) and 3) are more important than 1). The danger with Chinese manufacturers is that they will use the idea you provide for their own production and they will then attempt to sell that product to your own customers. These actions are what we seek to prevent via the NNN agreement.

In addition to the descriptive paragraph, please provide answer the following:

  1. Provide the full legal name of your company, including state/province of formation.
  2. Provide the address and related contact information that you will want for the contract.
  3. Provide the name and title of the person from your side who will execute the agreement.
  4. Does your company have a Chinese name? If so, what is it?
  5. Am I correct in thinking that you intend to use our NNN Agreement for discussions in China regarding manufacturing _________”

Please consider the following:

  1. Will you use this NNN Agreement for a single product or for multiple products?
  2. What is the best way to identify the products for which the NNN Agreement will be used? Ideally, we seek a clear, descriptive name that does not require attaching specifications or other proprietary information. Sometimes, even the name is proprietary. So we want to develop a designation that is clear, but that does not reveal more than you want to reveal.
  3. Do you plan to use this agreement with a single potential manufacturer or with multiple manufacturers?
  4. What types of information will you be providing to the Chinese side that you want to see protected by the NNN Agreement? This can range from providing a general concept all the way to providing the full production specifications as the preliminary to a hard price quote.
  5. Will you expect the Chinese side to do any design work during the initial discussion period? If so, please explain.
  6. Is your product protected by trademark, copyright or patent anywhere in the world? If it is, please explain
  7. After you disclose this product in China, are you interested in preventing the Chinese side from contacting any of your existing customers concerning your product or related products?
  8. We normally require that the Chinese manufacturer NOT contact any potential sub-contractors who would work in the production process. Please advise if you believe that this would be a concern in your situation. Note that some Chinese “manufacturers” are not actually manufacturers. They serve only as a middle man for the actual manufacturers. If you will use that kind of company, then they will need to be able to discuss your product with their subcontractors and we will need to allow for this.
  9. Please advise whether you have any specific technology items you desire to have protected in a heightened manner.

The second email was to another client for whom one of our lawyers had just completed an NNN Agreement:

Please find attached an NNN agreement for this project. Please note the following:

  1. We could not find any Chinese language information about the manufacturer. Please therefore have the manufacturer write in the Chinese company name, address and related information by hand in the appropriate places on the agreement.
  2. When executed by the Chinese side, please be sure that they stamp the agreement with their company seal in red. The stamp is important, so do not neglect this step.
  3. This agreement includes two exhibits. One is for listing the relevant products and the second is called a No Contact list. The purpose of the no contact list is to formally list out those customers of your company that you want to prohibit the manufacturer from contacting. If there are no such companies at this time or if you do not want to disclose names, just leave this exhibit blank at this time. You may want to use it later.
  4. It appears that this manufacturer will be working with numerous subcontractors. This is always a difficult issue. The approach here is the standard approach: subcontractors must be approved by you in advance. It is also best for you to require that subcontractor to execute a separate NNN agreement. However, this is often not practical. Our approach is to make the manufacturer liable for bad acts by the subcontractors. Note, however, that a very common way for copying to occur in China is to allow your designs to get into the hands of subcontractors and related parties.
  5. Be sure to make every document you provide to the Chinese side as confidential. In the case of subcontractors, ensure that the specific items that are provided to any individual contractor are carefully identified. The NNN agreement is of little use if you do not take care at the stage where specifications are distributed to the Chinese side.
  6. Note that this NNN agreement is intended to protect you only during the process of obtaining a quote from the manufacturer. For full production, you will need an OEM manufacturing agreement that deals with all the manufacturing issues in a comprehensive fashion.

What do you think?

Enhanced by Zemanta

The always helpful Quality Inspection Blog has a must-read post entitled, “Should you tell your China suppliers about your China price.” In the post, Renaud Anjoran, China quality control inspecter, extraordinaire, does a really nice job explaining the steps you should go through in sourcing your product from China (my comments are in italics):

Here is the sequence I advise importers to follow, when they source new suppliers:

Get in touch with at least 10 potential suppliers, and ask some questions (about their main market, their size…) to evaluate if they are good fit for your needs.  I worry about the high number of potential suppliers. For my reasoning, see below.

Request quotations (FOB, in USD) from them, to get a first pricing (without giving any target). Good idea.

Be in touch with them briefly on the phone, if possible. Human contact will show them that you didn’t sent that RFQ to 100 suppliers, and they will be more inclined to give a fast response. Great idea. A client recently told me that some of the better/busier Chinese factories will sometimes not bother responding to fax quotes.

You will likely see several very similar quotes: that’s the “market price”. Eliminate all the “outliers” that gave prices 20% higher or lower than the average. (If you are consciously looking to buy above the market price to get above-average quality, keep the highest quotes). Excellent advice.

If you have a team on the ground and if all candidates are in the same area, this is the best time to visit their factories. If this is not easy, continue discussing via email and phone, and pay for factory audits once you have narrowed your search down to 1 or 2 candidates. Makes good sense to me.

Give more information about your product and your quality requirements to the most interesting candidates. Don’t hesitate to give them your target price if it is very different from what they offer you. Ask them to justify their price level precisely. Makes sense. 

Don’t forget, in China price is very closely tied to quality. If you negotiate a very low price, most suppliers will end up saying yes. Then they will wonder how to make your products. They will probably use the very cheapest materials and subcontract production in a small workshop. You will get what you pay for. So true.

One last piece of advice: if you pay 20% above market price, all you risk is wasting 20% of the money you disbursed for your project (and actually it is closer to 10-15% because the FOB price is only a portion of your total landed cost). If you pay 20% below market price, you risk getting something that can’t be sold at all (which means you risk losing all your investment). Completely agree.

I will add one thing to the above. If you are going to be providing information to Chinese factories before contracting with them to purchase product, you should consider the confidentiality of what you will be providing to them for your quote. If possible, you should avoid providing anything you want to keep confidential, including any tradenames related to the product. If you cannot do that, then you should think about contacting fewer than ten factories and you should require those that you do contact to sign a Non Disclosure Agreement (NDA) or, better yet, what we call an NNN Agreement.

Also, if you will be revealing any of your trademarks or trade names to the Chinese factories and you have not yet registered those trade names in China, do so before the reveal. The most likely people to steal “your” trademark are those who are capable of manufacturing your prouduct and the only sure-fire way to prevent someone from stealing “your” trademark in China is for you to register your trademark in China before anyone else.

Many years ago, I attended a Seattle area High School basketball game between Roosevelt High School and Juanita High School. The big matchup was between two top 100 high school prospects, Marcus Williams for Roosevelt and Micah Downs for Juanita.
By that point, both Micah Downs and his father had already made clear they thought Micah was already NBA caliber (which he clearly was not) and that high school (he was now on his fifth one) ball was pretty much a waste of time for him. Roosevelt won the game, Downs played like a very good high school senior (not an NBA’er) and every single time he would touch the ball, the crowd would chant “overrated, overrated” and every time he would do something wrong, we would chant, “NBA, NBA.”
Though I have nowhere to shout it (except maybe here), I am often tempted to shout “overrated” when my clients or others make it seem as though one cannot do business in China because of its rampant lack of intellectual property (IP) protection. That excuse is overrated.
The reason it is overrated is because so many of the companies worried about protecting their IP in China do not really possess any IP in the nature of patents or copyrights. The issues they are concerned about fall more into the category of cutthroat competition than IP protection and those issues are usually best handled not through IP registration, but through Non Disclosure Agreements (NDAs) and trade secret provisions, both of which China is not all that bad in enforcing….at least when they are done correctly. And I am not being naive here because even before the Google thing, I have told clients they should operate under the assumption that someone in their organization will be passing on company information. I am not trying to make light of the very real IP protection issues in China, but I am saying that for most companies, that is not a good enough reason for ignoring China.
The Conference Board Review, which very rightly describes itself as “Ideas and Opinions for the World’s Business Leaders” just published an excellent article, entitled, “Is It the Real Thing?” making a very strong case that counterfeiting is an even bigger issue than believed and setting out some best practices for dealing with it. And as a sort of sideline issue to the main one, it published one by me, entitled, “In China, Piracy is no Excuse,” [go to the bottom of your screen for my article] in which I argue that China’s lack of IP protection is usually not a good excuse for not going into China.
And I do not even believe our two articles are contradictory.
Piracy and the lack of IP protection in China are huge issues. They are a huge issue for some companies, a big issue for some companies, an issue for some companies, and really not much of an issue at all for other companies. Nonetheless, for most (not all) companies they are not a valid reason for ignoring China entirely. Here are some excerpts from my article, explaining why:
I mention all this because companies’ anxieties about blown secrets resembles their fear of Chinese piracy: Everyone is afraid of it, but really only a small percentage of companies need worry much. It exists, of course, but how much impact does it really have on your business? With very few exceptions, my firm’s China clients have either not been hit with piracy or are too focused on making money from their own products to worry about it much. It is not nearly as much of an impediment to profits as believed.
* * * *
Foreign companies seeking to sell their products into China need to understand the role of wealth and price their products accordingly, if they can. If you are selling a product in China and it is always getting copied, you should consider reducing your prices there to better compete, assuming you can do so without angering customers elsewhere.
Companies doing business in China should also consider piracy prevention measures peculiar to their own products. For instance, my firm’s gaming clients, which typically sell their games on CDs here in the United States, overwhelmingly sell their games online in China, using all sorts of anti-piracy measures to do so. Can these security measures be hacked? I am sure they can. Are these companies making good money nonetheless? They are.
U.S. product manufacturers are sometimes so obsessed with piracy in China that they ignore what I see as an even greater threat: their own manufacturers. My experience convinces me that the most likely candidate to abuse your product is the company you are paying to manufacture it. This company is best positioned to send out “extras” of your product into China on its own, and this happens more often than you might imagine. The best way to prevent these “second shift” products from being produced and sold is to make sure your contract with your Chinese manufacturer expressly forbids this and then monitor, monitor, monitor.
What do you think?

Years ago, our Chinese lawyers used to get a fairly steady stream of panicked American callers who would call us a month or so after returning from China where they had showed their product, prototype or product drawings to Chinese OEM companies.These Americans were calling us in a panic because they had shown their product, prototype, or product design drawings around China (in some instances they had even left it there) and now everyone there had gone silent.

They would typically ask if we thought a Chinese company might be using their information to copy their product. I would then ask them if they had required the Chinese companies to sign any sort of secresy agreement before turning over the information. After a long pause, they would invariably answer, “no,” and then usually ask about suing. I would then explain how the copying of a product in this sort of situation was probably a violation of Chinese law, but . . . .

I realized the other day that these calls have almost completely ceased and I think the increasing use of nondisclosure agreements is why. Our more typical call now is from a consultant or manufacturer seeking our help in drafting a non-disclosure agreement (NDA) before heading off to China with a prototype/product/drawing for OEM quotes.


We love NDAs for foreign companies doing business in China. They are simple, effective, and telling.

Simple, because they tend not to vary all that much from company to company or from product to product.  We like putting in an attorneys’ fee provision and a provision regarding injunctive relief. We always do them in both English and Chinese, nearly always for a flat fee. We virtually always make Chinese the official language.

Effective, because the Chinese courts are getting familiar with them and will generally enforce them.

Telling, because we have found that if a Chinese manufacturer refuses to sign one, this is probably not the Chinese manufacturer with whom you want to do business.

NDAs:  Do not leave home without one.

Even better though is to use what we call an NNN Agreement.  When we work with sourcing companies and related OEM manufacturing arrangements, we almost never just draft a “straight NDA.” We instead prefer to draft a “non-disclosure/non-use/non-circumvention agreement” that we refer to as an NNN Agreement. When a foreign company contracts with a Chinese company to manufacture a product, the NNN focuses on the three primary “bad acts” that the foreign company needs to prevent:

  • The foreign company does not want its design revealed to a third party. To prevent this, a non-disclosure provision is required. Though this is an important issue in China, disclosure to an entirely unrelated third party is actually fairly uncommon. The bigger risk is disclosure to a related party. Many Chinese businesses have multiple subsidiaries and manufacturing is often done through a large network of subcontractors. Chinese companies are quite relaxed about passing around information within this network. A good non-disclosure agreement must focus on control of information within a network that the Chinese manufacturer itself may not consider as falling within the scope of a non-disclosure requirement.
  • Usually, the biggest concern for the foreign company is to prevent the Chinese manufacturer from making use of the product design to compete with the foreign company. For this purpose a non-use agreement is required. A good non-use agreement focuses on two issues. First, the agreement identifies the applicable intellectual property or confidential information of the foreign company and then authorizes the Chinese manufacturer to use that property/information solely to manufacture the product for the foreign company. Second, the agreement requires the manufacturer agree not to manufacture the product or any similar product under any circumstances, other than for the foreign company. This second provision is the most important as it prevents the Chinese manufacturer from manufacturing a similar product under its own trademark. Since many products are not covered by patent or other IP protections, the only way to prevent such “copy-cat” manufacturing is with such a non-use provision. Normal IP protections will not work, so a contractual agreement is essential. Since nearly all “off the shelf” American-style NDAs completely fail to account for this they are virtually worthless for China.
  • The foreign company also does not usually want the Chinese manufacturer to go around the foreign company by selling the product directly to the foreign company’s existing or future customers. After the Chinese manufacturer has manufactured the product for some time, it will likely have learned about the market and the customers for the product. It is only natural for the Chinese manufacturer at some point to go to the ultimate customer and say: “Look, WE are the company ACTUALLY making this product and since there is no patent or other IP protection applicable to the product, why don’t you just buy the product from us, for less?” This is called circumvention and it is extremely common in China. If you want to avoid getting “cut out” in this way, a non-circumvention provision agreement is required. Again, an “off the shelf” American-style NDA is not going to cover this.

Most non disclosure agreements we see are just modifications of the standard NDA used in the United States or in England and those agreements simply do not deal with the special problems of related parties in China and they treat non-use/non-circumvention either inadequately or not at all. Only a carefully thought out NNN Agreement that thoroughly resolves all of these issues is of any real value in China.

NNN Agreements work well for China so don’t leave home without one.