Had a great discussion with a bunch of our China lawyers the other day regarding how so many of our clients are expanding in Asia beyond China and of how so many of them have an Asia strategy, of which China is just one large part and usually initial part.

We then talked of how this has changed the work we do as their lawyers, especially in IP.

Five years ago, our typical manufacturing client would call us for legal help in starting a factory in China or for outsourcing their product manufacturing to a Chinese factory. With the former, we would help them set up a Chinese entity (either a WFOE or a Joint Venture) and with the later, we would draft an OEM Agreement. In both cases, we would discuss their intellectual property and typically help them file for a trademark or a patent in China, occasionally a copyright. Most of these companies were new to Asia, though some had operations in Europe.

Things are very different these days.

Many of our manufacturing clients have been making product in China for years and they are now calling us to add some other Asian country (usually Vietnam or Indonesia) to their manufacturing mix or because they now want to sell their China-manufactured product in China and/or somewhere else in Asia. These companies either have an Asia strategy or are seeking our help in formulating one. Whereas five years ago, a common question for us was “Shenzhen or Suzhou,” today we equally often hear “Hanoi or Jakarta?” Five years ago, we would get asked what we knew about “exotic” places like Yantai. Today it is exotic places like Da Nang.

Needless to say, it is not just manufactuing companies that need to guard their IP in China. Software companies, gaming companies, food and beverage companies, and consumer goods companies are registering their IP in Asia at what feels like a record pace. Balancing all the talk of a China manufacturing slowdown is the year by year increases in disposable income.

The “China-plus” strategies of our clients means that our IP discussions need to go well beyond China to include pretty much all of Asia. Five years ago, only around twenty percent of our clients needed to consider trademark or patent or copyright registrations in a country other than China. They were new to doing business in China and so they needed IP protection there. We would ask about their IP needs for the US and for Europe, but they had been in both places for so long that they were invariably covered.

Today, about half of our clients need IP protection in an Asian country other than China. Fortunately, most Asian countries (Japan, Korea, Vietnam included) have IP regimes quite similar to China’s. The real key for foreign companies expanding beyond China with their products is to be sure to recognize that whatever IP you registered in China probably provides you with little to no protection outside of China. In other words, in most cases, you must register your IP in whatever Asian country in which you are doing business. Also note that in your IP analysis, you must treat Macau and Taiwan and Hong Kong as countries completely separate from the PRC.

Got it?

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.

It is not uncommon for one of our China lawyers to receive an email along the following lines:

I am leaving for China tomorrow to meet with potential Chinese manufacturers and I just learned that a US-style NDA is of little to no value in protecting my trade secrets from Chinese companies.  Can you get me an NNN Agreement by tomorrow and how much will it cost?

Our response to these emails is usually something like the following:

I am sorry but there is no way we can complete such an agreement in one day.  The way we do these is to send you a fairly substantial questionnaire and we usually have follow-up questions after that. We then draft the NNN Agreement in English and then secure your approval to that.  We then have one of our lawyers fluent in Chinese translate it into Chinese for use in China. This typically takes us 3-7 business days.

We then talk about their other options, which vary depending on the nature of the business.

Over Thanksgiving we took on a quasi-rush job (well over one day) for a China NNN Agreement and we just completed that NNN Agreement.  Because the time frame was so short, we had to condense much of our instructions into fewer emails.  The following comes from the email from us to the client, enclosing the completed NNN Agreement. We are posting the bulk of this email below as it is helpful in explaining a bit more about what it takes to secure an enforceable NNN Agreement with a Chinese company.

  • An OEM agreement would contain similar non-disclosure, non-compete, and non-circumvent provisions to those in this NNN agreement, and if you were certain that a you were going to be using a certain Chinese factory to manufacture your product and that their price/quality/speed was acceptable, then you could just skip the NNN agreement and go straight to an OEM agreement.
  • It is of course difficult to know whether a given manufacturer can meet your specifications before it has manufactured a single item. The ideal way to handle manufacturing in China of unique products such as yours is to have three agreements. First, an NNN Agreement, for the situation where you reveal confidential information to determine, conceptually, if the Chinese party can make the product. Second, a development agreement, to cover the cost/procedure/ownership of rights/etc. 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 Original Equipment Manufacturing (OEM) contract, to cover the manufacturing and purchase of the product(s). Many vendors want to cram everything into one agreement, promising that they can of course manufacture what you want, and any product development will be folded into the manufacturing contract. It’s an awkward fit. A manufacturing agreement is not a development agreement.
  • I note that you are dealing with a Hong Kong company that is related somehow to a Chinese company. Your replies suggest that the counter-party should be the Chinese company, and we have drafted the agreement accordingly. As a general rule, the counter-party in an NNN agreement should be the entity to which you are directly sending confidential information.
  • Assuming that the Chinese company is the proper counter-party, you should be sure to follow the terms of the NNN Agreement. Only send information to the Chinese company. Do not send information directly to the Hong Kong company unless the Hong Kong company also signs an NNN agreement (which would have to be revised to be enforceable in Hong Kong). Be careful not to treat the Hong Kong entity and the Chinese entity as the same company — regardless of what the Chinese side might say. They are not the same company, and a court would not treat them the same.
  • You had asked about whether both ______ and ______ should be signatories. It does not matter much who signs the agreement on behalf of the Chinese company, so long as the company chop is affixed. That said, ideally you would find out the name of the Chinese company’s legal representative (listed on the company’s business license) and have that person sign the NNN agreement. It is also possible to have both _____ and ______ sign in their personal capacities — that is, to be personally liable — but I doubt they would agree to that.

There you have it.

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.

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?

A reader directed me to an excellent article in Material Handling & Logistics Magazine, setting out the basics for succeeding at outsourcing product manufacturing to China.  The article is by Michael Zakkour of Technomic and it is called The Ten Rules for Contract Manufacturing in China.

The article starts out by noting that “there are three overarching ‘must haves’ for producing/buying in China: a good supplier, a good contract and good IP protection.”  It goes on to say that if “you pay attention to the tiniest of details on all three you will likely have a profitable experience,” but “small lapses in any of the three could spell disaster.”  I completely agree.

It then maps out ten “simple rules to follow,” of which I will be discussing only the following, which are all legally related.

  • “Register all of your trademarks, copyrights and patents in China. China is first to file, not first to use. If you are not diligent with this, you will at some point lose your IP.”  I 100% agree.  See File Your Trademark In China. Now.

For more on best methods for China product manufacturing, check out the full article here.

It seems like 90 percent or more of the time when a company gets defective product from their Chinese manufacturer, the manufacturer blames a subcontractor.  Now I know that in some of these cases there was no subcontractor and in many more of these cases, it was not the subcontractor’s fault.  But we have always been of the view that subcontractors increase risk and, when possible, should be avoided. Far far too many China product sourcing problems stem from subcontractors.

In The Six (Not Five) Keys To China Quality, we spoke of why we typically write our OEM Agreements with Chinese manufacturers to preclude their using subcontractors:

We typically put a provision in our OEM agreements (which we nearly always do in Chinese for better enforcement in China against the manufacturer) mandating that the Chinese manufacturer cannot subcontract out the manufacturing. We have been doing this for years and, as far as we know, no manufacturer has ever violated this provision. I know many of you are dubious of this record, but hear me out. Let’s say the Chinese manufacturer has 30 customers for whom it manufacturers product. Let’s say only four of those customers have a no subcontracting provision (my guess is this number is more like to be two, but for the sake of argument, let’s go with four here). The China OEM manufacturer gets really busy and has to subcontract out some of its manufacturing. It can subcontract out the product manufacturing of any of its 30 customers, so why wouldn’t it choose to subcontract out the product for the 26 customers who have no contract provision prohibiting subcontracting? I call this the bike lock theory of Chinese law because the no-subcontract provision operates like a good bike lock. The thief can still steal your bike, but why would he when there are so many easier targets out there?

And when a subcontractor is necessary, we write into the OEM Agreement (and if there is a Supplier Manual, in there as well) that only subcontractors previously agreed to in writing by our clients may be used, along with a clear-cut liquidated damages provision for any violation.

I thought of the above today after a client of ours that supplies product to China told me of how Wal-Mart has adopted a “zero tolerance” policy regarding unauthorized subcontractors after a fire at a subcontractor to a Wal-Mart supplier in Bangladesh led to 112 deaths.

Bottom Line: If possible, your OEM Agreement with your Chinese manufacturers should prohibit subcontracting. If not possible, your OEM Agreement (and your Supplier Manual) should make very clear that only subcontractors authorized in writing by you will be allowed.  It (or they) should also make clear that any failure to abide by this policy will result in a stiff penalty (labelled as liquidated damages in your OEM Agreement) or, better yet, a termination of that particular supplier.

You have been warned.

Spoke with a US manufacturer the other day regarding the OEM Agreement we are working on for him.  This manufacturer has been manufacturing in China for about a decade and he quickly let me know that one of the things that drives him nuts is how his Chinese manufacturers “change prices” on him, no matter what the contract says.  My response was to say, “I know.”  He then asked if we could stop that with our OEM Agreement.  My response was “probably not” and then I explained to him why stopping it might not be such a good thing anyway.

“Take your widgets,” I said (actually I mentioned his actual product, but you know what I mean).  “Stainless Steel is a big part of that.  If we put in your contract that your widgets have to remain at X price for three years, we may be asking for trouble.  What happens if the price of steel doubles during that time,” I asked. “I’ll tell you what will happen,” I said.  “Your Chinese manufacturer will either go back to you and ask to be able to raise its prices in light of its greatly increased costs for Stainless Steel or it will secretly start replacing some of the stainless steel in your widget. Which would you prefer?”

His response was pretty much as follows:

I get it.  You are absolutely right.  I know that because that is exactly what keeps happening to me.  The manufacturers start changing their products for me and always for the worse. Sometimes they do come back to me and ask for a price increase and then we negotiate one.

We talked a bit more and he agreed that the ones that came back to ask for a price increase were overall much better manufacturers than the ones that secretly changed the product on him and that he was no longer doing business with any of those.

I then told him that the generally best way to handle pricing in his situation is to set a price for maybe a year but be ready to be flexible on it.  I then noted that very few Chinese factories hedge their material goods pricing and that for right now at least, adjusting prices, no matter what a contract says is still pretty common in China, probably more so than just about anywhere else.  I then told him of how Chinese companies drive our commodities clients crazy.  One client in the paper business says that when the price of paper plunges, the way non-Chinese companies typically handle that is to pay the higher price to which they previously agreed or to come clean and say that they cannot afford to pay that price and then negotiate a lower price, with the expectation that they will be indebted to the paper seller for the foreseeable future. But Chinese companies, I am told, simply reject the paper, claiming it is bad and thereby avoid having to pay the higher price.  In other words, Chinese companies out of all companies seem to be the least willing to recognize that a price is a price.

Just one more thing you need to account for in doing business with China.

What do you think?

I’ve been deleting old emails today and in doing so I have deleted far too many that relate to China product quality problems.  Here’s the most recent such email, with all identifiers removed to protect the victim:

My company purchased hundreds of _____ from a company in China for about $65,000. Most of these _______ were defective when we received them. They [the Chinese manufacturer] told us that they would make up for this on our next order. We made another order and we got more defective _________.

We then upgraded the _________ to what was supposed to be a better quality ________. Again, we have received defective ________. We are
now getting many returns from our customers who bought these _______ and
this is costing us tens of thousands of dollars.

I would like to know if there is any way that we can get our money back for
all the bad ________. We have all invoices, communications, and videos and
pictures.

We also want to know if we can sue for attorney costs to resolve this matter
as well?

My response, which is pretty much pure template these days, was as follows:

I hate to have to tell you this, but you have probably set yourself up so that a good solution is very unlikely.
You say that you have all “invoices, communications, and videos and pictures,” but you fail to mention the most important thing of all, which is a signed AND sealed contract in Chinese that makes very clear exactly what the Chinese manufacturer was to provide you and the penalties it owes for having failed to do so.
Once you have the sort of problem that you had with a Chinese manufacturer, you run away.  Fast.  And you don’t go back for more and then back again.  Ever.
We typically charge a flat fee on these sorts of cases, along with a percentage of whatever we recover, with the fee and the percent based on how we access the case after reviewing all relevant documetns.
When we take on these cases, we review all the documents and try to get anything back for our clients by writing a letter in Chinese threatening to sue.  I don’t think that will work here and I would urge you not to retain us.
The other thing I would urge you to do is to not order anything from China again without a good contract in place. Good contracts usually work by driving away the bad Chinese companies and by forcing the good ones to toe the line.  China does not typically award attorneys’ fees unless that award is set forth in a signed contract. For more on what you can be doing to protect yourself by from China product problems, I urge you to read the following:

I am truly sorry this has happened to you and I am also sorry that I cannot be more positive about it, but the last thing I want to do is to add to your pain by taking more of your money on something that probably will not give you any value back.
Not surprisingly, I did not hear back.

Just received the following comment to our post, How To Find And Deal With Chinese Manufacturers:

I have a question,
I sent a picture of a unique [product] and they sent back an email saying that they would like to manufacture it and when I said mine they corrected me by stateing ours.
is this normal?
How should I deal with them.
how does something like this work?
Thanks

We get this type of question shockingly often.  Usually, it comes from someone who just returned from China calling to say that they just spent the last week in China, meeting with a whole slew of potential Chinese manufacturers, and they just realized (oftentimes by having read one of our blog posts on the need for a Non Disclosure Agreement) that they should have required the potential manufacturers to sign a Non Disclosure Agreement BEFORE showing them their product or prototype.

So what can be done?  How should this company deal with their manufacturer? How can this company protect its trade secrets now?  With this particular company, all may not be lost. and that is why I struck its specific definition of their product and replaced it with the generic word, “product.”

If this company provided its product to just one manufacturer and is now planning to buy from just this one manufacturer, this company may end up doing just fine.

What this company should have done BEFORE it showed its unique product to anyone in China (or anywhere else in the world for that matter) is to have required that Chinese manufacturer to sign a comprehensive NNN Agreement written in Chinese and tailored for enforceability in China.  But that was not done, and the question is what can this company do now that it has returned without a China NDA of any kind.

This company can and should go to this particular Chinese manufacturer and say something along the following:

We want you to manufacture our product, but for that to happen, we need you to sign this OEM Agreement.

The OEM Agreement this company provides to its chosen Chinese manufacturer should contain each and every trade secret provision that should have gone into the NNN Agreement this company should have required the Chinese manufacturer to have signed before showing the Chinese manufacturer anything.  If the Chinese manufacturer signs the OEM Agreement, the company will have its trade secret protections. If the Chinese manufacturer refuses to sign the OEM Agreement, the company will have a big problem.

In our experience, Chinese manufacturers will virtually always sign a legitimate OEM Agreement containing trade secret protections becuase the Chinese manufacturer wants the manufacturing business.  I would estimate that Chinese manufacturers sign our OEM Agreements around 98% of the time and those few times that they do not it is because they are not a legitimate company and they do not want to be bound by legitimate requirements.  In other words, the Chinese manufacturer that refuses to sign an OEM Agreement does so because they intend to steal trade secrets or fail to deliver on their quality promises and they do not want to sign a contract that could effectively penalize them for doing so.

The much tougher problem is the company that comes back to the United States having shown its unique product to ten Chinese manufacturers.  That company can get a protective OEM Agreement from just one or two of them (i.e. the ones whom it is going to use for manufacutering) and it will then always have a problem with eight or nine of them.

The real solution, however, is not to go to China without an NNN Agreement at the ready.

If you are seeking to have your product manufactured in China, I suggest you scour  the following regarding NNN/NDA Agreements:

And the following regarding China OEM Agreements:

And the following regarding other key issues arising from China product outsourcing: