Archives: OEM agreements

How many of you know what “deep six” means? How many of you have used equally difficult to comprehend slang/words when emailing with your Chinese manufacturer?  How many times has your Chinese manufacturer emailed you back to seek clarification of such words or of anything at all?  I am betting not often.

I had a great conversation the other day with one of my law firm’s savviest China clients.  This is a person/company who has been engaged in China OEM manufacturing for nearly twenty years.  I asked him how things were going and he launched into how he was now communicating with his Chinese manufacturers only in Chinese and that doing so had immediately led to all sorts of improvements.  He said that he had made the switch after realizing that so many of the problems he had been having with his suppliers were due to “silly miscommunications.”  He said the last straw (there I go again with the slang) was when his supplier confused “June” for “July” and delivered product a month late.

He now pays a US-based professional translator (the same one every time) to translate everything he sends to his manufacturers, including (and especially) all emails and all Purchase Orders. His OEM contracts were already in Chinese.  For why it makes sense to have your China OEM Agreements in Chinese, check out China OEM Agreements. Why Ours Are In Chinese. Flat Out (there I went again with the slang).

What he kept telling me is how much more often he is now communicating with his manufacturers and how much more often his China manufacturers are writing back seeking clarification. I said that I thought it interesting that his Chinese manufacturers were seeking clarifications more often now that he was communicating with them in Chinese than when he was communicating with them in English.  He responded by saying that they had previously been too embarrassed to seek clarifications because that would be to admit that their English was not very good.  He also thinks (and I agree) that there are a whole slew of mediocre translators in China who will give their bosses a bad translation rather than admit that they do not understand the English.

Interesting idea communicating with Chinese manufacturers in just Chinese.  I like it.  What do you all think?

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?

Product manufacturing in China’s coastal regions has become increasingly challenging for manufacturers and buyers alike. Costs such as wages and rent have risen dramatically over the past five years at the same time that the economies of major buyers have suffered severe setbacks. This has put tremendous pressure on the small and medium businesses that make up the manufacturers in the export-oriented belt extending from Jiangsu down to Zhuhai.

There have been many predictions that this process would fundamentally change the structure of manufacturing in China. Since as far back as 2008, it has been confidently predicted that basic manufacturing would move from coastal China either to inland China or to other countries in SE Asia. Even the Chinese government has predicted a shift in the coastal region away from basic manufacturing to high-tech, high value added, high investment manufacturing consolidated in the hands of a few highly capitalized players.

However, this has not happened. Basic level export oriented contract manufacturing in China remains concentrated along the coastal belt. Many businesses that experimented with inland China and SE Asia are now returning to the coast. There are two primary reasons for this. First, the Chinese coast has an in-place manufacturing support base that simply cannot be duplicated anywhere else in China, Asia or probably the world. Ports, rail and road networks are first rate. Electricity is generally available and black outs are rare. Ancillary support is available everywhere. If you are making clothing and you need a new type of button, you can find a supply and have it delivered within 24 hours. If a manufacturing line goes down the repairman arrives in 4 hours with the replacement part in hand.

Second, China has developed the ability to implement complex production plans in way that cannot be matched elsewhere. Foreign buyers have grown accustomed to showing up at a Chinese facility with a mere product sketch which then becomes a marketable product, rolling off the production line in quantity within 9 months. Moreover, the Chinese have become masters at managing production of such new products on a massive scale that simply cannot be duplicated.

As a result, even though prices are rising, foreign buyers are still actively purchasing product in China’s coastal regions. This applies both to purchases of basic non-brand products and to purchases of highly customized OEM products. The reason is simple. The buyers simply have nowhere else to go. Thus, to the surprise of many, the China coast remains the manufacturer to the world. Recent trade statistics bear this out. In the face of enormous headwinds, Chinese exports have increased substantially in 2013: 25% in January, 21.8% in February and 11.7% in March.

Though exports continue at a high rate, we do see a major new trend in purchases by foreign buyers from the manufacturing sector. In the past, foreign buyers were oftentimes content to purchase product from their Chinese manufacturers without using a written contract and with no long-term commitment on the part of the buyer or the manufacturer. We know many foreign companies that have purchased product from the same manufacturer for over ten years on a per purchase order basis.

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.”

Chinese manufacturers fully understand that the purpose of these new contracts is to impose liability on them that they have been able to shrug off in the past. As a result, many Chinese manufacturers resist entering into this kind of agreement. They have had a free ride for many years and they want that ride to continue.

Foreign buyers are now more often insisting on contracts that impose liability on their Chinese manufacturers as I have described above. This trend is just part of the process of maturation of the Chinese manufacturing system and there is nothing anyone can do to stop the process. Smart foreign companies are getting accountability or moving on to another factory.  Chinese manufacturers that get the message and enter into and comply with detailed purchasing and manufacturing agreements will survive and those that don’t won’t.  It is that simple. I have discussed these things with many Chinese factory owners and none have disagreed.

Note however that this applies in the same way to foreign buyers. Foreign buyers that continue to absorb the cost of Chinese manufacturer non-compliance will be swept away. The rising cost of Chinese product coupled with the vigilant approach of major retailers means that absorbing these costs is no longer economically feasible. Buyers who do not protect themselves and continue to operate on a per purchase order basis will be looking at an enforced career change in their future. The coffee shop in my neighborhood in Qingdao is advertising for a new barista. Send me your name and I will make an introduction.

For more on the kind of written contract required to hold your China manufacturer responsible for things like bad product or late delivery, check out the following:

 

 

One of my favorite “trix” employed against American companies doing business in China is the dual language contract, where the English language version is silent on which language controls.  We often see this from companies that come to us for the first time with a contractual problem.

Dual language contracts can be incredibly dangerous.  If you have a contract in both English and in Chinese, which language controls?  Well, if both of the languages say that one language controls, that one language will control.  So for example, if both the English language and the Chinese language versions say that the Chinese language version controls, then the Chinese language version will in fact control. Similarly, if both versions say that the English language version controls, then the English language version will control.  These are the easy and safe examples.

It is everything else that so often gets American and British and Canadian and Australian companies in huge trouble.

If you have an English language contract and a Chinese language contract that are both silent as to which version controls, the Chinese language version will control in a Chinese court and in a Chinese arbitration.  So what this means is that if your English language contract says that a product must be strong enough to withstand 500 pounds of pressure and your Chinese language contract says that the product need only be strong enough to withstand 300 pounds of pressure and neither contract version says which controls, the Chinese version will control and the product need only be strong enough to withstand 300 pounds of pressure.

And here’s the thing: Chinese companies just love using a contract with an English version that is more favorable to the foreign company than the Chinese version and then relying on the English speaking company to assume that the English language version will control.  I mean, English is the world’s language for business, right?

But what if the English language version explicitly states that it will control? You should be okay with that, right?  Not necessarily.  If the Chinese language version also explicitly states that it will control, the Chinese language version will control.  If the Chinese language version is silent, then the English language contract controls.

As we noted in China OEM Agreements. Why Ours Are In Chinese. Flat Out, our China lawyers usually draft our clients’ contracts in Chinese, with an English language translation. That way at least our clients know what they are really signing.

Bottom Line: No matter what your English language contract says, it behooves you to know exactly what your Chinese language contract says as well.

I have given four China law speeches in the last month (two live and two via webinars, here and here).  Three out of the four talks generated questions as to whether what I had said applied to Hong Kong or to Taiwan.  My answer in all instances was a resounding “no.”

Mainland China has its own legal system, separate and apart from Taiwan, Hong Kong and Macao.  In thinking about the laws of those places, you should think of them as different countries.  Now there are definitely some instances where the laws in Mainland China are different for companies and/or legal matters coming from Taiwan, Hong Kong or Macao, but those instances are not terribly common and they become even less common when the matter involves a Western company. Your default position should always be to assume that the laws are different and to always assume that whatever you do in the PRC will not carry over to Taiwan, Hong Kong or Macao.

For example, when we do NNN Agreements for our clients, we make clear that the Agreement we will be drafting “will apply only to PRC China manufacturers. It does not cover Taiwan or Hong Kong or Macau companies that may handle manufacturing for you as intermediaries. If you will be dealing with companies from Taiwan or Hong Kong or Macau (or from any country other than the PRC), please let us know so we can make allowances for that.”  We do the same thing for our OEM Agreements as well.  In my future talks, I am going to early on make clear that my speech is confined to the PRC.

I thought of all this today after reading a post on the China IP Insider Blog, entitled, IPR: A territorial animal, emphasizing how intellectual property rights are “territorial” and what you register outside of China does not constitute registration in China:

Since working on the China IPR SME Helpdesk I have organised and attended scores of events on various intellectual property (IP) topics. Following presentations from legal experts we always allow some time for a question and answer session. The most common question asked by European businesses is a variation of the following question:

“If I have a (insert trade mark or patent) registered in (insert EU country). Is it valid in China?”

The answer is easy; it’s a resounding no. Intellectual property rights are territorial due to the fact they are offered and governed by each country’s legislation. Although some international treaties exist, they generally only facilitate the application process in different countries.

The post goes on to note that the fact that China currently exists in a “one country, two systems” situation only exacerbates the confusion, but that “the IP systems in Mainland China differ from those in Hong Kong, Macau and Taiwan and different registration is required in each territory.”  It then does a really nice job postulating as to why so many people get it wrong regarding the universality of IP registrations:

Through dialogue with many European Helpdesk users I have identified that one reason why many people presume IP rights skip borders is that intellectual property is sometimes considered a moral right. Additionally, with such easy access to information internationally through the internet it is very possible that a trade mark registered in Italy for example can easily be seen by a Chinese competitor if the Italian company uses the internet to sell or market their product.

And as to why this mistaken belief in the universality of IP can be so deadly:

Unfortunately this can lead to problems for your European business. China is a first to file system which means that the first person to register the trade mark is the legal owner in China even if the trade mark has been used by a different company in another country. Whether obtained morally or not, possession is not just nine tenths of the law, it is the law!

It concludes by advising that the “best way to protect your intellectual property therefore is to protect it in every market you operate in (manufacture, sell, may move into in the future etc.),” or as we say here, File Your Trademark In China.  Now.

Every December, we get an even greater than normal number of phone calls from companies that have received bad product or no product at all and the past two weeks have been no exception.  And as is almost always the case, I blame the “victim.”

I blame the victim because without exception, in every single case where we have gotten such a call, the non-Chinese buyer has done a lot of things wrong in its sourcing of product from China and now it is, to put it somewhat harshly, paying the price for that.

But what so often really drives me nuts about these people is that after I tell them exactly why my law firm has zero interest in their case, some of them say something like “I knew you can’t trust Chinese companies” or “I knew they had no law there” and then they usually say something like “I’m never going to do business there again. The risks are just too high.”

Wrong. Wrong. Wrong.

What I always want to tell them, but pretty much never do, is the following:

What are you talking about?  You did NOTHING to try to protect yourself.  You didn’t research the Chinese company before sending them money.  You didn’t use anyone to monitor quality control.  You didn’t use anyone to write you a contract that would actually work in a Chinese Court.  So really, what did you expect? I hate to tell you this, but we have hundreds of clients who buy from China all the time and they almost never experience anything close to what you are going through.

It reminds me of a relative I have (not on my side of the family, I might add), who during the tech boom would brag about how he had gotten so good at the market he would be earning 20% a year forever.  Yes, he actually said that.  But what is even more interesting is that after the market crashed and he lost a ton of money, he then started preaching how the market was rigged and he would never buy stocks again, not once even referencing his prior claims.  As my older brother the stockbroker is always saying, “genius is a rising market.”  But the corrollary to that for this relative is that a falling market is a rigged market to be avoided by everyone.

Wrong. Wrong. Wrong.

Just like there are ways to do well in the stock market (over time), there are ways to do well in the China product sourcing market.  The way to increase your odds of getting the product for which you paid is to do the following:

1. Make your product purchases from China under a well-drafted contract that is enforceable in China. Purchases under informal purchase orders simply do not work for China.  For more on China OEM Agreements, check out the following:

2. The contract with the Chinese manufacturer must provide for a mechanism where the foreign buyer can exercise constant control over the quality of the Chinese product. Liability for defect must be made clear and it must fall hard on the Chinese side. If possible, no defective product should ever be permitted to even leave the Chinese factory. If defective product is discovered outside of China, the Chinese side must be absolutely liable for dealing with the problem. The standard procedure (in China, anyway) for dealing with defects through a discount on future purchases must not be used.

3. The foreign buyer must actually follow through and constantly monitor the quality of the product. The best contract with the best procedure is no good if the foreign side does not follow through by rigorously implementing the procedures outlined in it. As I mentioned above, this is an expensive and tiresome process. Parties that do not follow through are almost guaranteed to experience problems in China. These problems are an irritant to the Chinese side but can be fatal to the foreign side. For this reason, the only side that has any incentive to follow through is the foreign side.

Is China product quality getting  better?  Yes and no. Chinese manufacturers are not doing a better job on their own at maintaining quality. In fact, if left on their own, much evidence suggests they are doing worse. But yes, the legal system and quality control systems have progressed to the point where aware and active foreign companies can force Chinese manufacturers to operate in a reasonably acceptable manner. “Forcing” means doing things right.

What do you think?

A member of our China Law Blog Group on Linkedin left the following comment (modified slightly) regarding Chinese company names, prompting this post:

Recently I happened to meet with a Chinese lawyer in Qingdao who told me about how the Province [Shangdong] registers the Chinese name of a company. The companies are registered only with Chinese names. Let’s say for a contract with an Indian or a US company they do use just the English name. He says it is compulsory to have the contract in English and in Chinese also. Otherwise the Chinese company simply can deny its English name to avoid participating in the arbitration. Is this true? How we can make a contract foolproof without making a Chinese contract?

Great questions.

Let me start out by saying that we are of the view that in most cases it makes sense to have your contract with a Chinese company be in Chinese.  We explain why we take this position in China OEM Agreements. Why Ours Are In Chinese. Flat Out:

Because international contracts are so often between parties from different countries, they commonly are written in two or more languages. Nearly all of the contracts we draft for our Western clients doing business in China are in English and Chinese (though about ten percent of the time, we also translate them into German, Spanish, Korean, or French as well). This duality of language can, if not handled properly, pose big problems.

When we do a contract in both English and Chinese, we always call for the contract to specify ONE official language to control if there is a dispute. We do not advise drafting a contract that is silent on the official language, nor do we advise drafting contracts that call for both English and Chinese to apply. Having two official languages pretty much doubles the chances for ambiguity and pretty much doubles the attorney time (and fees) that will be incurred in fighting over the meaning of the two contracts. It is expensive enough litigating on one contract; there is no benefit litigating on two.

So the question for us comes down to whether English or Chinese should be the official language of the contract and the answer to that question requires we first decide where we would most like to see disputes resolved. If we go for arbitration in English (and if the Chinese manufacturer actually agrees to this, which is quite rare), then we almost certainly will want English as the official language. But if we decide the Chinese courts will be the best place to resolve conflicts, then we want Chinese to be the official language.

But, having said this, it is not true (as many seem to believe) that English language contracts will be deemed invalid by Chinese courts or arbitral bodies.

But what about company names?  The only official company name is the Chinese language version and this is true as well for WFOEs in China and Joint Ventures as well.  If you are going to form a China WFOE, you must come up with a Chinese name for your WFOE and that Chinese name will become your one and only official name.

But must one put the Chinese name on any contract with a Chinese company?  No, this is not required, but it is certainly smart to do so. I have actually never heard of a Chinese company claiming it is not them who signed a particular contract using the English language version of their name, but it absolutely does not surprise me to hear that happens.  Our firm has always used the Chinese language version of a Chinese company’s name, even on the English language version of our contracts and we do so for clarity. We also typically put in the address of the company as well and sometimes its license number as well.

I can certainly imagine a Chinese company seeking to get out of a contract by claiming that it never signed one because the contract at issue does not contain its Chinese language name. But at the same time, I also think that someone facing such a claim ought to — in most instances — be able to prevail against it by marshaling evidence to show that it was indeed the Chinese company that signed the contract. This will be particularly easy if the Chinese company has a well-known and often used English language name or if the English language name is a direct translation of a unique Chinese language name.

I actually think the bigger issue regarding contracts with Chinese companies is whether the contract is sealed or not.  In How To Write A Chinese Contract That Works, we wrote on how Chinese companies were notorious for trying to get out of contracts they had not sealed/chopped:

For written contracts in China to be effective, one of the following must be true:

  1. The company’s legal representative signed it. Chinese law provides that a company’s legal representative has apparent authority to bind the company. This means that even if that representative lacks the actual authority to bind the company (maybe because the board of directors or the shareholders never gave the representative the authority to contract with you), the legal representative’s signature will bind the company. There is, however an exception to this and that is when you know that the legal representative lacks the authority to bind the company.
  2. The contract is appropriately sealed.  An appropriate seal (oftentimes called a chop) is applied to the contract. It does not matter who applies the seal, so long as it is the right seal. This means it must be sealed either with a contract seal that sets forth the name of the company or, as is more commonly done, with the Company Seal. Each Chinese company has only one company seal (no copies).

Chinese companies are notorious for trying to get out of contracts by claiming they never actually signed them or that they were signed without the proper authority and so if your contract is big enough and important enough, you should consider doing all of the following to minimize even further the likelihood of the Chinese company seeking to get out of your contract:

  1. A signature from the company’s legal representative. Of course, you must first confirm from the company’s business license who exactly is the company’s legal representative.
  2. A resolution from the company’s board explicitly approving the contract and authorizing the legal representative to sign it.
  3. The affixation to the contract of the company seal or the company’s contract seal.

In that same post, we set out the basics of what it takes to write a good Chinese contract:

If you want to greatly increase your chances of being able to enforce your contract with your Chinese counter-party, you should do the following (you should do a lot more than this, both within and outside your contract, but I am limiting this post to just those things directly related to being able to enforce the contract and its terms)

  1. Have a written contract (see this, this and this);
  2. Have that written contract be in Chinese;
  3. Have that written contract set out clearly how disputes are to be resolved and, even more importantly, pick the right forum for those disputes;
  4. Have that written contract set out in excruciating detail what the Chinese company must do to be in compliance with the contract;
  5. Set out the liquidated damages the Chinese company must pay if it fails to comply with the contract;
  6. Make sure the Chinese company signs AND seals your contract.

It is impossible to make any contract foolproof in that there will always be risks in any deal, but doing the above will increase your odds.

What do you think?

 

 

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Nearly a year ago, we wrote about the importance of including “seal confirmation” in your China due diligence:

One of our recurring themes is the need for due diligence when working on any business matters in China. Most foreign companies think of due diligence only when they are planning to make an investment. Most companies are not aware that due diligence is required whenever you do any kind of business with a Chinese company. If you do not already know the Chinese company with which you will be conducting business, you must confirm that the company really does exist and that you are dealing with the actual company and not an impostor.

I want to share a conversation I had yesterday with some young Chinese lawyers who work for the one of the largest and best law firms in Shandong province. I was discussing with them the question of whether or not the company seal on a particular document was valid or not. It seemed like a simple matter. The resulting conversation was not so simple.

When asked how they go about confirming the validity of a seal, the lawyers told me that “you have to go the town where the company is located.” Once there, you then have to determine if the seal is registered. Often the seal is not registered as registration of seals is not mandatory in China. Then you inspect various documents filed with the local authorities to determine if the same seal was used on those documents. If the seal is registered, or if the same seal was used on all company documents filed with the local authorities, you know that the seal is valid.

Even this is not enough. Even though the seal is valid, you still have to determine if the seal is being used in an authorized manner. Just on the surface, there are two possible issues. First, an impostor may have created a fake company seal. Second, someone within the company may be using the seal in an unauthorized manner. The only way to resolve these issues is to actually visit the company at its headquarters and to ask: is the person who stamped this document employed at your company? If the answer to this is yes, you then must ask whether the person is authorized to do this particular business.

An affirmative answer to both these questions is the only way you can be assured that the signature and the seal on your document are valid and will effectively bind the company. There is no other way to do it: a visit to the relevant  government office and to the company office is required. There is no service available to do the work. You have to hire a Chinese licensed attorney to do it. A Chinese attorney is normally required because local governments rarely open their files to a private person and they certainly will not open their files to a foreigner.

My first response to all of this was to say that this is far too expensive a procedure for normal commercial transactions. The Chinese lawyers looked at me with a mixture of amusement and contempt. They said that they understand my response since it is typical of their North American and European clients. They further stated that they are amazed at the naivete of their foreign clients on the need for basic due diligence in commercial transactions. One lawyer looked at me and said: “What do you think we do all day at this law firm. Most of our young lawyers and legal assistants are primarily engaged in basic due diligence about potential business partners of our Chinese clients. We travel to the local offices and we charge for the expense. Our Chinese clients willingly pay the fee because they know the risk is too great to act in any other way. We constantly see foreign companies enter into contracts without doing any such investigation and it continues to surprise us. You say that our form of due diligence is too expensive. We say that being cheated is far more expensive. Given that the chance of being cheated in China is extremely high, it makes no sense to us to take the risk. Our Chinese clients would never enter into an important contract without a personal investigation of the other side and we find it very strange that these foreign clients who know even less about China will willingly take a risk that virtually no Chinese company would take.”

It makes sense to take seriously what these young Chinese lawyers are saying. Let me give you just one example of what can go wrong in China. Say you are dealing with a large and well established Chinese company. There is no question that this company exists and that it makes the product that you wish to purchase. Now ask yourself this: are you really dealing with that big company? Or are you dealing with an impostor? How do you know?

It is easy in China to fake company seals, business cards, bank accounts and even a website. The unsuspecting foreigner makes a deal with the impostor and sends funds to the bank account. Product never arrives. The foreigner contacts the well established Chinese company and that company truthfully responds by saying “we have never heard of you.” It turns out the foreigner had been dealing with a fake, virtual company the entire time. This happens all the the time in China. Trust me when I tell you we see instances of this at least once a month.

One of the services we are constantly providing for our clients is what I call the “first pass review” of a company seal. In this review, one of our China lawyers who is fluent in Chinese and very experienced with Chinese contracts will review a seal for our client. This review consists of pretty much nothing more than looking at it to determine whether it may be fake or not. If this review cannot determine that the seal is fake, we then suggest our client conduct a more thorough review to confirm that it is real. This is because our first pass review is good at spotting obvious fakes, but it certainly is not good at making sure that a seal is real or that the seal really did come from the company it represents or that it really was authorized by the right company. But as a gratis first pass, it does have its benefits. Shockingly often in fact.

Let me explain.

As stated in the post above, at least once a month we come across an instance where there is something very wrong with the seal/Chinese company with whom our client is thinking of entering into a  deal. My favorites are when we detect that the seal is a fake, which has been happening more often in the last six months than in the past — it is amazing how direct and quick a correlation we see between a declining economy and a rising incidence of fraud. Just last week, I was cc’ed on some emails between two of our lawyers doing a first pass review of an alleged company seal. The email exchange was as follows:

First email:  Attached please find one of our OEM agreements, signed and stamped by the Chinese side. Please note the following that seem out of whack to me:

1. The seal is in blue and not red ink
2. The seal is rectangular and not circular
3. The seal is almost illegible — does that matter?
4. The signature is the Chinese manufacturer representative’s English name

Also, the client tells me that he signed it and scanned it to them for their signature, but they sent back a copy with their signature but without his, and asked him to sign the copy they had signed. Is that normal?

Second email:  None of this is normal or legally binding. The seal should be circular, the ink should be red, and the company name should be entirely in Chinese. The seal should also always be completely legible.  And why is the manufacturer signing with his English name?  A lot is not right here and you should so instruct the client.

Aww snap. You didn’t know?

Blog post at Letters Blogatory, entitled, “Dueling Translations,” expresses surprise/concern over how both parties in an ultra-high stakes international litigation matter “actually submitted dueling certified translations of the Ecuadoran appellate court’s decision (Chevron’s is here [link no longer exists], the Lago Agrio plainitffs’ is here [link no longer exists]).” The post questions this as a waste of time/money:

Really? Dueling translations? I know that Randy Mastro and James Tyrrell are top lawyers at major law firms, and that this is extremely high-stakes litigation, but I would like humbly to suggest that the two of them sit down for a beer summit and see if they can find some way to reduce what has got to be the awe-inspiring litigation budget.

I disagree. He/she who controls the language can control the case. The following spring to mind:

1.  Whenever the other side in a case submits a translated document, I almost always move to strike it unless the translator has attached a declaration/affidavit regarding the translation. Even with that, I virtually always have someone on my side confirm that the translation is accurate. About 85% of the time the translation is “accurate” but about 99% of the time, it has been translated in a way that favors the side doing the translation. This needs to be pointed out to the court. Just by way of example, there are languages where the same word can be translated either as “shall” or as “should.” Those are two very different meanings.

2. Finding a good translator for depositions is very difficult. In Seattle, there is a Russian translator who everyone knows is fantastic and it is pretty common for both sides in a case to agree that she will be the only interpreter for the entire case. I know of no such translator in any other language here. I once had a case where the French translator was so bad that I was pretty much able to nullify anything at all harmful my Swiss client said at her deposition, simply by pointing out how bad this translator had done overall. It was not so much that the translator’s English was so bad (he was French) it was that it was his first job translating at a deposition and he simply did not know what his role was supposed to be. He did not realize that legal translation means translate, not help with the questions or the answers.

3. I had another case which involved depositions of around 8-10 witnesses from the PRC. The other side was taking these depositions and they flew all of the witnesses to Hong Kong for deposition. The other side also flew in a court reporter all the way from New Zealand. But their big mistake was using a Hong Kong based interpreter whose first language is Cantonese, not Mandarin. She was terrible.

As I always do for depositions where the deponent speaks a language other than English, I brought along someone both completely fluent in the deponent’s language and someone I completely trust to watch over the translating. In this case, it was my co-blogger Steve Dickinson. The other side brought along a Chinese speaking attorney as well. What ended up happening is that both parties essentially reached an agreement that whenever either side had a dispute regarding the translator’s interpreting, they could object, at which point Steve and the Chinese lawyer would seek to reach an agreement. If an agreement could be reached, the correct/better translation would go on the record. if no agreement could be reached (which was surprisingly seldom) we would defer the argument for the court. All this meant that each deposition took probably twice as long as it would have taken had the other side brought in a decent interpreter.

I could go on and on, but you probably already have gotten my drift. Bottom line, the translation matters.

What do you think?

For more on the impact of the language/translation chosen, and for why we draft most of the contracts in Chinese for our American clients doing business in China, I urge you to read “China OEM Agreements. Why Ours Are In Chinese. Flat Out.” To grossly summarize that post, we figure that if you are going to end up before a Chinese judge you are going to want to give him or her a contract that he or she can understand. If your contract is in English, the Chinese court will use its own translator to translate it into Chinese. This means you are not going to have any influence on what it is going to say nor will you even know what it is going to say until you have sued.

I love it when a blog post just lands in my lap, and one just did. It is a couple of emails from two of my firm’s lawyers to two different clients, both of whom recently retained us to draft OEM Agreements for production of product by factories in China. Both clients are in the process of changing their Chinese manufacturers and this time around they want a strong and enforceable supplier agreement with their new Chinese manufacturer.

I am doing this post to give an idea of some of what should go into a Chinese manufacturing agreement.

Since we have a fairly standard initial questionnaire we send to our clients when we being working on China OEM manufacturing agreements, I have combined the two emails into one, further camouflaging the companies involved. Here are the questions posed by the emails:

  • What is the name and contact information of the Chinese manufacturer?
  • What sort of products will the Chinese manufacturer be making? Do you anticipate that these products will change over time? Will the volume change over time?
  • Where do you anticipate selling your products In particular, will you be selling it in China?
  • What are you expecting regarding shipping terms?
  • Will you be using this OEM agreement only with this specific Chinese manufacturer, or will you be wanting to re-use it with others?
  • What arrangements will be made for packaging prior to shipment?
  • Are you concerned about your manufacturer going around you by directly selling a competing product your customers?
  • Exactly what will you want to be  done with any defective product?
  • Do you have an existing purchase order (PO) that you intend to use for your product orders from this manufacturer? If so, please provide us with a copy.
  • How are you anticipating pricing and other terms will be negotiated? On a purchase order basis? On an annual basis? Some other way?  If you submit a purchase order and is not accepted by the Chinese side, what happens? In other words, is the Chinese side bound for some period to make a certain amount of product at a certain price, or is the Chinese side only obligated to make product for you after it accepts your purchase order?
  • How many of the deal terms have been negotiated at this point? From the documents you have sent us, it appears that only the very basics have been negotiated: 40% down, 60% before delivery/shipping, plus certain quantity discounts. These are not great terms from your standpoint, but fairly typical for deals with manufacturers in Southern China (i.e., Shenzhen, Guangdong, etc.).
  • What sort of arrangements have you made for inspection and quality control, and what sort of warranty terms have you negotiated? This question is particularly important in that many manufacturers in the south of China insist on a no-warranty provision.
  • What are your main concerns in this deal? I ask this both so I can focus on the provisions that matter to you, and because it can help determine the choice of law and the choice of venue. From what I know so far, your main concerns seem to be twofold: (1) getting a high quality product and (2) protecting your intellectual property (i.e., ensuring that the Chinese manufacturer does not sell your product behind your back and/or steal your tooling).
  • What exactly is the tooling for this product? Does the Chinese manufacturer already have all of the tooling in question?
  • Has the Chinese manufacturer already signed an sort of agreement/memorandum of understanding (MOU) with you, even if only in English?
  • Are there any unresolved issues involving your previous manufacturer ? For instance: have you gotten all of the tooling back from the previous factory? Are there any outstanding invoices or payments due?

After we get answers to the above questions, we virtually always write back with a whole slew of follow-ups.

For more on what it takes to have/create a good OEM Agreement, please check out the following: