China AttorneysBecause of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a super fast general answer and, when it is easy to do so, a link or two to a blog post that may provide some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

Though China’s economy is — for the most part — doing well these days, competition among factories is intense and we are seeing the divisions between winners and losers accelerating. Well-run factories that actually appreciate good contracts are growing. Poorly run factories which make their razor thin margins by skimping on materials or with tax sleight of hand, seem to be crashing. These crashing companies are dangerous as they are desperate and that leads to frequent problems. This is my somewhat long-handed way of saying that our China lawyers are getting record numbers of emails from disgruntled foreign product buyers, usually asking us to help them recover money they are owed.

In nearly all cases, we have to tell them that we do not believe we can help them and that paying us even to try would be throwing good money after bad. At some point in our email conversations they often ask “what then should we do” and our response is usually the following:

Three things. One, if you are going to continue manufacturing in China, but with someone else, you should not let on that you have a problem with your existing factory. And if you have already told them of your concerns, start downplaying them, and fast. You do not want this factory to start taking measures to make it difficult for you to go to another factory. For more on this, I suggest you read Why Changing China Suppliers Can Be So Risky. Most importantly, if you have not already registered your trademarks in China (and maybe your design patents as well), do so immediately. You do not want your old factory to get those and they often do. See Make China Trademarks a Priority. Two, do NOT go to China to try to resolve your dispute with your existing supplier. For why this is so important, check out China Product Defects, Lawsuits, Hostage Taking and Exit Ban: Please, Please, Please Read This! Three, don’t buy again from China without first conducting at least basic due diligence on your supplier and getting China-specific manufacturing contracts in place. See China Manufacturing Contracts: Not So Simple.

China employer audits China employment lawyers

As I have previously written, no (foreign) employer is too small for China’s regulators and in some respects the smaller you are, the more you need one. I say this because when a company with 5,000 employees has a problem with five employees, it’s not that big a deal, but when a five-employee company has a problem with two employees, it can be such a big and costly problem as to cost the company its China business. To be a well-protected employer in China, you need a well-written China employment contract and a China-centric set of Rules and Regulations, no matter your company size.

China’s employment laws are strict and protective of employees at all companies, especially those that are foreign-owned. If you as an employer fail to follow all mandatory employment laws, your employee will pursue you regardless of your size. Our China employment lawyers constantly get questions from China employers after they have been reported and/or sued by an employee China employee — mostly Chinese but increasingly non-Chinese as well.

The below is an amalgamation of the sorts of emails we frequently receive:

I cannot believe that I just got served with a lawsuit by one of my former Chinese employees. We are a small business and we pay all our taxes and we have always treated all of our employees right, including this one. We paid her really well and we were never late with her wages and we even gave her extra vacation days. We also paid all of her mandatory employee benefits and a few optional ones as well. We always did our best with her. And then she quit, completely voluntarily, and yet she is now suing and claiming we owe her double her monthly wages for not having a written employment contract with her? As you can see, her demand is totally unreasonable.

We then have to explain that with no written employment contract the employer stands virtually no chance in this arbitration.

It is not uncommon for foreign employers in China to state that they have done or are “doing their best” with respect to treating their employees well and following China’s complicated (and localized) employment laws. The problem is that neither the Chinese government nor its courts nor arbitral bodies care how hard you try. Your other law-abiding actions are not a mitigating factor in determining the penalty you will need to pay for having failed to enter into a written contract with your employees or for whatever other violation you may have committed.

The burden is on you as the employer to ensure you have a proper written employment contract fully executed by the parties. The best practice is to have your new employee sit down and sign a hard copy of the employment contract on her first day and you then retain an original copy of the fully executed contract for your records.

Consider this hypothetical. Employer asks Employee to sign a hard copy of the employment contract during the on-boarding process. Employee says: I will need some time to review this and I will take it home to read and I will return a signed copy. Employer says okay, but the Employee never returns a signed copy. Employer never makes an effort to “track down” that contract. Employee sues months or years later seeking a penalty from the employer for failing to use a written employment contract. Under this scenario, the Employer will be liable to Employee for failing to execute a written employment contract. If this sort of scenario sounds unlikely to you, let me just tell you that nearly every time we audit a company’s employment situation we find some percentage of employees working without signed contracts.

Now same facts as above, but Employee returns a signed copy with a fake signature. What will happen? Based on real cases with similar facts, Employer will probably be held liable for an employer penalty because there is no written employment contract bearing Employee’s actual signature, unless Employer has convincing evidence Employee faked the signature to “cheat the system” (which is a high evidentiary bar to meet).

If you are not sure you have current written employment contracts for all your employees, now would be a good time to check on this and fix it.

China lawyers IP
Don’t gift your IP to China

When working on complex contract manufacturing agreements, most of our clients tell us their main goal is to protect their intellectual property. This is particularly true for designers of start-up products where much of of their IP consists of trade secrets and know-how that require a formal agreement with the manufacturer. However, as we work with the client, we frequently learn that the client has already gifted their IP to the Chinese manufacturer. Making a gift to your family and friend is a nice gesture. But no foreign designer of a product intends to make a gift to a Chinese factory owner. The gift is unintended, and the consequences are virtually never good.

Here is what usually happens. We begin drafting the contract manufacturing agreement. In our standard set of questions, we ask about the status of molds. The client then reports something like the following: “We have already provided the designs for our molds to our  Chinese manufacturer and the manufacturer has already fabricated the molds. The current issue is focused on payment for the molds.”

We then ask our client about its plans for commercializing their product idea and fabricating production prototypes. The client then reports: “We have been working with the manufacturer for months to fabricate a production prototype. The manufacturer agreed to engage its own engineers and designers for this process. We now have two prototypes and we are ready to begin production. The only issue now is how to pay for the work on the prototypes.”

In both cases, we ask the following sorts of questions:

  • What form of documentation did you use in connection with providing your confidential design information to the manufacturer?
  • What did you do to formally protect your IP?
  • What did you do to make clear you own the entire design in the molds?
  • What did you do to make sure you own all of the design work that went into the design and manufacture of the prototype?

Far too often, our client answers with something like this: “The only documentation we have in place is a simple purchase order  for the molds. There is no documentation at all relating to the prototype. We were told that using purchase orders at this stage is standard so we did not think about it.”

The above scenario with slight variations is almost standard for start-up companies making their first foray into China’s manufacturing market. We then have to tell our client something like the following: “You indicated your primary goal is to protect your intellectual property. But, by providing your design data to your Chinese manufacturer with no documentation and by allowing the Chinese side to design and fabricate molds and prototypes, you have effectively given your IP to the Chinese manufacturer. The issue for us now is to determine whether or not the manufacturer will agree to return this gift. Sometimes they will, usually they will not.

In this setting, it is possible for the Chinese manufacturer to appropriate the product and to begin producing the product in its own name. When the foreign designer protests, the Chinese manufacturer points out that it did the actual design and fabrication work for the molds and it also did all the design and fabrication work for the product prototype. And since it did all of this work, it owns the design. And here’s the thing: legally, so long as the Chinese manufacturer does not infringe on the registered trademark of the foreign party, it is generally free to manufacture the product and sell it wherever it wants.

Absent formal written agreements, litigation in most countries to determine who owns what in terms of the product is fact intensive with the eventual outcome usually unclear. The lack of clarity simple kills off the chances for most start ups to market its product effectively. So when this situation happens to a foreign start-up, it can mean commercial death. The Chinese side is counting on this. A dead company cannot support litigation required to resolve the issue. Even for well established companies, this situation can cause substantial economic damage, since the effective marketing of a new product is made so difficult.

In most cases, however, the Chinese manufacturer is not interested in selling the product under its own name; what it usually wants is to create a situation where the foreign buyer does not have the option to have its product manufactured by any other manufacturer. The Chinese manufacturer wants to ensure it is the sole entity with the right to manufacture the product. By getting this it essentially has the pricing power of a monopoly on manufacturing the product.

Here is how it works out on the ground. At some point, the foreign buyer decides it wants to change to another manufacturer because a) the manufacturer substantially raises its price, b) the product is consistently defective, or c) the manufacturer cannot keep up with the required production volume. The foreign company wanting to go to a new manufacturer requests its existing manufacturer transfer its molds and the product prototype to the new factory.

The manufacturer refuses to comply with this request. The manufacturer says: “we own the design of the molds and we own the design of the product prototype. We will agree not to manufacture the product for ourselves or for any third party. On the other hand, you are not free to take the molds and prototypes to any other factory. You can only manufacture the product if you use our manufacturing services to do so. In legal terms, the Chinese manufacturer is saying it will provide an exclusive license to the foreign company to manufacture a product for which the design is owned by the Chinese side.

If the foreign buyer insists that it wants to move its manufacturing elsewhere, some Chinese manufacturers will say that the foreign buyer is free to start from scratch with a new factory. Other Chinese manufacturers will take a harder line and state that manufacturing the product in any other facility is an infringement on its IP and it will take action to prevent that infringement. In the last couple of years, more and more Chinese manufacturers are doing whatever they can (usually via cease and desist letters and litigation) to make manufacturing by others impossible. Either way, if the product is complex in any way, the foreign buyer is in a situation where it is required to work with the original Chinese manufacturer. This then means the foreign buyer can take no practical action to deal with the various issues that caused them to want to move to a new manufacturer. In particular, the foreign buyer is helpless in dealing with a price increase.

Many clients are skeptical when we explain this situation to them. They simply cannot believe they gifted their most valuable asset to another company. Some tell us that their Chinese manufacturer is an honest and upright company that would never act in the ways set out above. Others say that since they paid for the work, it must be the case that the Chinese factory will recognize that the foreign side owns the design and is free to take the molds and prototypes to any other factory for manufacturing.

In our experience, the situation is quite different. In the past decade, in every case on which any of our China lawyers have worked, the Chinese factory took one of the positions outlined above and refused to back down. In other words, once you have gifted your IP, you should not expect the Chinese side will graciously return the gift. Once the gift has been made, the Chinese side will keep the gift and make use of the gift to its advantage.

What does the manager of the start-up tell its investors after having given away the IP at the core of its product and its business? Our China attorneys have had to help with these sort of conversations and we probably hate these conversations almost as much as the managers themselves.

So in an effort to make life easier for product manufacturing start-ups we fervently propose you EARLY ON make use of the following agreements when working with Chinese manufacturers:

These agreements should be executed in advance of any transfer of design information to the Chinese manufacturer. Purchase orders come at the end of the process, not at the beginning. Unless you want to gift your IP to your Chinese manufacturer without realizing it. Oh, and while you are at it, you should seek to register your trademarks in China and look into registering your design patents (and maybe other patents) in China as well.

China joint venture lawyers
Smile. The fake China joint venture scam is easily avoided.

Our China lawyers have over the last few months have been getting way more emails and phone calls from foreign companies (U.S. and European) either telling us they’ve been scammed or seeking our assistance in determining whether they are about to get scammed.

Anyway, in recognition of this recent in scamming, I am writing (again) about the sorts of scams we usually see, along with providing tips on how to avoid them. In Part 1, I wrote about the scam of tricking someone to come to China to sign a deal. Part 2 was on the scam of getting money for supplying products and then supplying nothing or, more commonly, something that isn’t even close to what the foreign company bought and paid for. Part 3 was on the switched bank account, which is — by far — the most difficult to avoid scam. Part 4 was on a scam where a Chinese company gets you to provide it work or services (or perhaps even product) in return for stock or stock options that you can never really own because you are a foreigner. Part 5 involved a fairly recent, increasingly common, and highly sophisticated scam whereby a Chinese company claims to be interested in investing in a foreign company but in reality it has that interest only so far as it can use it to steal your IP.

This part 6 post is on what we call the fake China Joint Venture, and it is an oldy but a goody and — dare I say it — one of my favorites. The reason I say it is one of my favorites is because anyone who falls prey to it brings it on themselves, at least in part. Our China lawyers have seen this one quite often and as far as I know, it has always involved an American company, which I fear says something about American naïveté.

This scam is really very simple and it pretty much always goes down the same way. It starts with a Chinese company convincing a foreign company to do a joint venture. The foreign company then contributes something to the joint venture to secure its ownership stake in it. This contribution virtually always consists of money, but it also often involves other assets as well, such as intellectual property, equipment, personnel (usually unpaid) or know-how. The Chinese company says it will handle the setting up of the joint venture and the foreign company readily agrees to this.

But instead of actually setting up a real joint venture with the foreign company having an actual ownership stake in the new company, the Chinese side simply takes the assets from the foreign company and does nothing official towards forming a joint venture. Most of the time the Chinese company never even sends the foreign company any remotely official documents regarding the alleged joint venture, but sometimes it sends fakes. Either way, the end result is that the foreign company believes it to be the part-owner of a China joint venture and it starts acting accordingly.

Usually for years everything is fine, but then the foreign company begins to wonder why it has never received any money whatsoever from the joint venture when it now seems to be doing so well. So they contact their supposed joint venture partner (the Chinese company) and then when they fail to get any answers, they contact a China lawyer to look into bringing a lawsuit. The China lawyer does some quick research (and by quick, I mean really quick) and then realizes there is no joint venture.

In some circumstances it may be possible to sue individuals and companies outside China for fraud but for that to work you need for the foreign country to have subject matter and personal jurisdiction and even if both of these jurisdictions are present, one must still effect service of process under the Hague Convention and, perhaps most importantly, have some means of collecting on any judgment awarded. Foreign courts are not going to be quick to claim jurisdiction over the ownership of a company in China and Chinese courts are certainly not going to be very quick to say that a foreign court has the power to determine ownership of Chinese companies. All this combines to mean that in most instances the duped party has no good recourse.

How do you avoid this scam happening to you? Very very simple. You retain a qualified lawyer early on to make sure a real joint venture gets formed with your company as one of its owners.

China trademark lawyersIn part one of this two-part series, we discussed the general strategy when filing a non-use cancellation, and the steps you can take to increase your odds of success. In this concluding second part, we’ll discuss the timing of non-cancellation filings, and a specific strategy when dealing with a trademark squatter.

Unless motivated by spite, people file non-use cancellations to eliminate trademarks that stand in the way of their own trademark applications. They do so at one of two times: before filing an application (to eliminate potential obstacles) and after their application has been rejected (to eliminate cited obstacles).

In an ideal world, you would link a cancellation to a trademark application so that the CTMO examiner (or TRAB panel, as the case may be) would note the linkage and suspend their efforts until the cancellation was decided. But we do not live in an ideal world, and the CTMO does not suspend examinations or appeals until cancellations are decided. Instead, you have to work out the timing yourself and play the odds that the non-use cancellation will be decided first.

It’s an inexact science. If you are appealing a rejection, the window to file an appeal is so short that you have little choice but to file the appeal and non-use cancellation at the same time. But if you haven’t filed an application yet, the best way to ensure that the cancellation will be decided first is to file the non-use cancellation, wait a few months, and then file an application. Don’t wait too long, though: once the trademark owner has been notified (usually within 2-3 months of filing the non-use cancellation), they might file their own (new) application. Many applicants don’t bother trying to game the system; they file a non-use cancellation and a trademark application at the same time, and if they are unlucky enough to have the application examined first, they just file an appeal, secure in the knowledge that the cancellation will definitely be decided before the appeal is.

Filing a non-use cancellation against a trademark squatter has some unique challenges. Many trademark squatters never use the mark in commerce: their sole goal is to monetize the trademark by selling it to the “real” trademark owner, or to the highest bidder on the secondary market.

A canny trademark squatter may take a couple actions to foreclose the possibility of a non-use cancellation. First, they might sell a handful of supposedly branded goods to a friend or colleague via e-commerce, thus satisfying the use in commerce requirement.

If the trademark is particularly valuable, or the trademark squatter particularly canny, a few branded products will be sold online to foreclose the possibility of a non-use cancellation. But this is quite rare.

This creates an opportunity for the “real” trademark owner. With a trademark squatter, the registration won’t even be vulnerable to a non-use cancellation until 3 years after the registration date. And if the squatter is intent on maintaining those trademark rights, they’ll file another, identical application before the three-year term is up, thereby preserving their rights even if the first registration is cancelled.

But two can play that game. The real trademark owner could file first – even before the three year term is up – and then file a non-use cancellation exactly three years after registration. Sure, the application will probably be rejected at first because it’ll be decided before the cancellation, but then you can file an appeal, and the cancellation should be complete by the time the appeal is decided. This strategy takes time to execute, and it is not without risks. (What if the trademark squatter filed a new application before you? What if the cancellation fails because the trademark squatter actually had used the mark in commerce?) But if it works, you can retrieve the mark at a much lower cost, without involving the courts, and without having to pay off a trademark squatter. Alternately, you could use the pending filings as leverage to negotiate a lower price from the trademark squatter.

Yes, it would be nice if China provided recourse against trademark squatters by more straightforward means: namely, by trademark oppositions (for pending applications) and invalidations (for existing registrations). Maybe that day will come, but for now trying to take on trademark squatters head-on is a loser’s game. The way to defeat them is by using the Chinese trademark system against them.

Needless to say, this strategy is predicated on the assumption that the trademark squatter has not used the mark in commerce. The more research you can do before filing a non-use cancellation, the better. Because if the squatter has in fact used the mark such that they can defeat a non-use cancellation, they’ll probably increase the sale price, figuring that you must really want the trademark.

China lawyers for China scamsOur China lawyers have over the last few months have been getting way more emails and phone calls from foreign companies (U.S. and European) either telling us they’ve been scammed or seeking our assistance in determining whether they are about to get scammed.

Anyway, in recognition of this recent in scamming, I am going to write (again) about the sorts of scams we usually see, along with providing tips on how to avoid them. This is part 5 of the series. In Part 1, I wrote about the scam of tricking someone to come to China to sign a deal. Part 2 was on the scam of getting money for supplying products and then supplying nothing or, more commonly, something that isn’t even close to what the foreign company bought and paid for. Part 3 was on the switched bank account, which is — by far — the most difficult to avoid scam. Part 4 was on a scam where a Chinese company gets you to provide it work or services (or perhaps even product) in return for stock or stock options that you can never really own because you are a foreigner.

This part 5 involves a fairly recent, increasingly common, and highly sophisticated scam whereby a Chinese company claims to be interested in investing in a foreign company but in reality it has that interest only so far as it can use it to steal your IP.  The Chinese company usually starts out by claiming a strong interest in sending over a lot of money in return for a small ownership interest in your company. Many times, the Chinese company will talk about how its investment is not for short term profits, but to help you do an IPO from which everyone will get rich. This all sounds good, but with this comes usually comes something like the following from the Chinese company:

Our company will become one of the owners of your U.S. entity. And since we will be co-owners of the technology underlying your product, there is no reason for you to protect the technology from us. There is no reason to enter into any sort of confidentiality agreement (like an NDA or an NNN Agreement). We do not want legal or financial hurdles to get in the way of the IPO that will make us all wealthy.

So the foreign company provides its technical information to the Chinese company it now sees as its partner and benefactor. In return, the Chinese company starts using your IP and never funds its alleged investment. And for good measure (and to set itself up for a force majeure defense), the Chinese company will often then blame the Chinese government for its inability to get money out of China to fund the investment.

By using this “fake investment” technique, the Chinese company has legally or quasi-legally acquired the technology while paying little or nothing for it and there is nothing the foreign company can do. And it is true that foreign investment from Chinese companies must be approved by the Chinese government. So what is there to say?

On the software side, we usually see the the Chinese company offer to invest a large sum in the foreign company and as part of its grand plan, it will propose to set up a company in China that will eventually be owned by the foreign company. It will then arrange for the software technology to be released to the Chinese entity without restriction. Why should the foreign company spend time and money licensing its software to this Chinese company that it will eventually own a part of in any event. Oh, and this Chinese company will surely be doing an IPO very soon anyway.

In this scheme, there are various delays in getting approval for both the investment in the foreign company and in providing for foreign ownership in the Chinese entity. After two or three years of delay, and after the Chinese company has extracted all of the technology/information it requires, it apologizes for being unable to secure Chinese government approval to invest in the foreign entity and for not being able to give the foreign company any ownership in the Chinese entity because foreign investment in Chinese domestic companies is pretty much prohibited. See yesterday’s post on the China Stock Option Scam.

The end result is that the Chinese company has acquired the foreign technology virtually free of cost and there is usually nothing the foreign company can do about that.

For another common way in which foreign companies are tricked out of their IP, check out China and The Internet of Things and How to Destroy Your Own Company.


China stock options lawyer
Don’t be tempted by ths China stock option scam

Our China lawyers have over the last few months have been getting way more emails and phone calls from foreign companies (U.S. and European) either telling us they’ve been scammed or seeking our assistance in determining whether they are about to get scammed.

Anyway, in recognition of this recent in scamming, I am going to write (again) about the sorts of scams we usually see, along with providing tips on how to avoid them. This is part 4 of the series. In Part 1, I wrote about the scam of tricking someone to come to China to sign a deal. Part 2 was on the scam of getting money for supplying products and then supplying nothing or, more commonly, something that isn’t even close to what the foreign company bought and paid for. Part 3 was on the switched bank account, which is — by far — the most difficult to avoid scam.

This part 4 is on what our China team calls the China stock option scam — a relatively new, relatively sophisticated scam that has left many tech people and small tech companies in its wake.

This scam starts out with a Chinese company offering stock ownership as an alternative form of payment. The typical scam usually goes like this. The Chinese company — usually in the tech sector — is in desperate need of the expensive skills or knowledge of a foreign person or entity. The Chinese company tells the foreign tech people or entity that it “needs your services but because we are just a start up we will need to pay you in stock instead of cash.”  So, instead of paying cash, the Chinese company offers founders’ stock or employee stock options in their Chinese entity. Just as is the case with Silicon Valley founders stock/stock options, the idea here is that the Chinese entity will go public (“do an IPO”) and the stock it has given out will then provide its recipients with big returns.

Unfortunately, this is nearly impossible because foreigners cannot own stock in Chinese domestic companies not already listed on a stock market. So any such option or stock transfer is void from the start. Foreigners are not permitted to be shareholders of Chinese domestic companies, nor does China recognize the concept of nominee shareholders. Chinese companies will also use this Silicon Valley approach of offering a stock option package as a key benefit in the employment package. By offering stock options, the Chinese company can pay less and secure greater loyalty, while still exploiting the skills and extracting the knowledge of foreign individuals in developing an innovative software or other high tech product.

This exploitation/extraction period typically lasts one to three years, at which point the Chinese company tells the foreign individual, “sorry, the Chinese government has now informed us that we cannot issue stock options to you.” Sometimes, to better hide the scheme, the Chinese company will propose a series of fantasy work arounds, such as elaborate nominee schemes illegal under Chinese law. These proposals often convince the foreign person to waste another year or two with the Chinese company. But, in the end, the result is always the same. The Chinese company defaults on its promise to provide the foreign individual with stock in the company and the foreign individual is left high and dry. Since the founders stock/stock option scheme was void from the start, there is nothing the foreigners can do to enforce their rights in China, since they never had any such rights.

A similar scam is often perpetrated on foreign entities. The foreign entity has a technical service of great value to the Chinese tech company. The Chinese company then says: “We need your services, but we are growing so fast we simply don’t have the ability to pay you in cash for that. However, since we are growing so fast, it is certain we will soon do an IPO on the Shanghai stock exchange. So, instead of paying you in cash, we will agree to pay in you in stock options. Our stock will in the end give you way more money and by working with us, you will gain entry into the lucrative Chinese market and highly profitable work with other Chinese companies will follow.”

This scam results in the same sad result as the employee stock option scam. First, as with employee stock options, a foreigner cannot own stock in the Chinese entity, so the option is void from the start. Second, the private Chinese entity never does an IPO on the Shanghai market, so the whole concept was an illusion. Third, the only thing the foreign entity achieved was to identify itself as an easy mark and there will be no future profitable work available to it in China. Finally, the foreign company does not figure out the scam until after it has already transferred its service or valuable information to the Chinese entity.

There are a couple of elegant variations Chinese entities use to implement the Chinese stock scam. In the rare case where a private Chinese company actually completes an IPO, the listing is on a foreign exchange: usually either Hong Kong or the United States or London, where due to Chinese law requirements the actual listing entity is not the Chinese company for which stock options or stock were purportedly given. Instead, the listing entity is some form of subsidiary or other affiliate of the Chinese company, so that when the IPO does actually take place, the holder of the scam option or stock in the Chinese company can legitimately be told: “your stock option (or stock) is with the Chinese parent company; you do not have an option with the affiliate actually listed. Sorry.”

For all intents and purposes, private companies in China are  locked out of China’s domestic IPO market. See this Wall Street Journal article from yesterday. On the other hand, such companies have become attractive targets for private equity financing. But the story here is the same. The private equity financing occurs in China, resulting in a big payout to existing shareholders of the Chinese entity. The foreign stock option holder looks for an equivalent benefit. The Chinese entity then responds: this was a private equity deal, not an IPO. You did not own any stock at the time of the private financing, so you are not entitled to any benefit.

The way to avoid this scam is easy. Do not accept promises of stock options or stock in a Chinese company in place of employment compensation or payment for services. Any Chinese company that makes the offer of payment in stock is either ignorant of the requirements of Chinese law or intentionally committing fraud. Either way, foreign individuals and companies should refuse to work with a Chinese company in return for stock or stock options.

UPDATE: I got the following email today:

Nice series. There’s a new variation that has been tried on me and that’s blockchain “tokens” in a Chinese company “about to do an ICO” in lieu of cash. Since China takes an incredibly dim view on ICOs as a fund raising mechanism, this is an even more fraught method of “payment” than sham stock options. Of course the answer is “well, we’re doing our ICO outside of China, to which the response is “the company won’t be worth much if you’re in prison, though, will it?”

Good point.

China lawyers China scams
Muster your forces against China scams

We constantly write about this particular China bank scam  because our China lawyers constantly get contacted by smart companies that have fallen victim to it. I personally received two emails in the last month from companies (one that were bilked out of between $63,000 and $155,000.

Last year the Wall Street Journal wrote about how there has been an increase in criminals break into email accounts and change bank-account information to capture payments intended for suppliers:

The increasing prevalence of the schemes has drawn the attention of law enforcement. Attackers who once pretended to be executives directing subordinates to transfer money are using new techniques, including malicious software to break into email systems and redirect the payments, said Rick Alwine, a supervisory special agent with the Federal Bureau of Investigation’s Cyber Division.

And as the Wall Street Journal noted, these bank account scams are increasing and most involve China:

In an analysis of 44 recent fraudulent transfers, 84% of the transfers went to accounts in China and Hong Kong where it is more difficult for victims to recover their money, the FBI alert said. The FBI says it has logged nearly 18,000 reports of business email scams since 2013 accounting for $2.3 billion in losses, and complaints about these scams more than tripled last year, compared with 2014.

The Wall Street Journal describes these scams as follows:

When the buyer sends an order, the scammers step in, ultimately intercepting the seller’s invoice and changing payment instructions before sending it back to the buyer. With the modified invoice, funds are sent to the criminals instead of to the seller.

This scam usually involves your regular Chinese supplier asking you to make a payment or payments to a new bank account, though it sometimes can involve your very first payment to a new Chinese supplier. Then even after you make the payment or payments, your China supplier insists you still owe it the full amount (oftentimes with added fees) because it never received your payment. When you explain to your China supplier that you in fact did pay it, your supplier points out that the bank account to which you sent the funds is not theirs and that you still owe the money.

The Wall Street Journal article then discusses how easy they can be to pull off and how difficult they are to stop, but provides no solutions;

True business email compromise is almost invisible to both victim companies involved in the transaction,” he said. “It’s going to take a lot more effort to stop it than a simple reminder to phone the CEO before wiring money on his behalf.

But there are solutions and they do involve a lot more than reminding your people “to phone the CEO before wiring money on his behalf. We advocate every business do the following to minimize its chances of falling victim to this common scam:

  1. Get to know your suppliers who speak English (if you don’t speak Chinese) and get your supplier’s landline phone numbers as that cannot be hacked. Call if you have any concerns.
  2. Get your supplier’s bank account information in advance and ask them to refer to “bank account information document” on their invoices, rather than listing out full bank details every time.
  3. Check your bank account every day, maybe even twice a day. If you catch a wire early enough you can sometimes stop it.
  4. Do a first small wire to confirm the account.
  5. If possible, paying your Chinese suppliers to their bank accounts in mainland China as that is generally safer than paying them overseas, be it Hong Kong, Taiwan or anywhere else.
  6. Have a special procedure set up with your suppliers for confirming bank account changes .
  7. Have an internal procedure for confirming all payments over a certain amount.
  8. Get an insurance policy that covers computer hacking or fraud and make sure it covers this sort of scam. We actually have had good luck convincing insurance companies that they need to pay off on such policies.

What can you do if you have already been victimized? We do the following when retained by a company victimized by this fraud:

1. We determine whether there are any insurance claims to be made. This is usually your best chance of recovering all your losses, but do not expect your insurance company to pay without a fight. We help by explaining to the insurance company how these scams happen and why you are entitled to coverage under your policy and we get the Chinese supplier to help as well.

2. We try to get some monetary contribution from your Chinese supplier by letting it know that it was (or might have been) their computer system the scammer hacked and therefore it should pay at least some of our client’s loss. Much depends on our client’s relationship with its Chinese supplier and on what the Chinese supplier perceives its future relationship with our client will be.

3. We work with our client to minimize problems with its Chinese supplier and if that relationship needs to be severed, we counsel them on how to do so without creating all sorts of new problems. See Why Changing China Suppliers Can Be So Risky.

4. We seek to determine if there is any chance to recover anything from the perpetrator. This is an expensive and time-consuming process and there must be a lot of money involved for it to make much sense. Nonetheless, we find that our at least having run this option to ground helps immensely in dealing with both the Chinese supplier and with our client’s insurance company, neither of whom want to pay anything until they are convinced that our client has done everything it could do to try to recover from the crooks themselves.

Be careful.

China Employment Law Female EmployeesAs today is International Women’s Day, this would be a good time for a quick overview on China employment laws that directly relate to female employees. Since there are so many national and regional and even local laws and regulations regarding female employees in China, this post necessarily seeks only to hit the high notes.

First, do not forget to give your female employees half a day off as International Women’s Day is their holiday (or follow the applicable holiday policy in your employer rules and regulations if it’s more generous than the law)!

Second, let me emphasize that female workers are always a big issue in China (not just today), primarily because they are accorded many additional special protections under China law. If you have been following my posts here or if you have a copy of my book (The China Employment Law Guide), you probably already know that employees who are pregnant, nursing or on maternity leave receive special protections exceeding those in many other countries. However, it is important to also note that these are not the only protected subgroups of female employees; they are simply the most often mentioned because the issues relating to them are the most common and because it is on these issues that foreign employers so often find themselves in trouble. For example, China’s laws also provide special protections for female employees during their menstrual periods. Many localities in China require employers provide a short (usually 1 to 2 days) paid leave to employees suffering from serious menstrual issues or to those with very heavy flows during their periods, so long as the employee provides a doctor’s note proving her condition.

Terminating a China employee is generally very difficult because China is not an employment-at-will jurisdiction and terminating a female employee is often even more difficult, especially if the female employee has a special status such as pregnancy. Subject to limited exceptions, employers in China are prohibited from unilaterally terminating an employee who is pregnant, nursing or on maternity leave. One common myth is that female employees in such special status can never be fired. This is wrong as these employees may be unilaterally terminated without severance for the employee’s failure to satisfy the employer’s conditions of employment during a probation period or if based on employee misconduct or wrongdoing. Alternatively, such an employee may be terminated if the employer and the employee agree to mutually terminate the employment relationship. See Terminating a China Employee: Why Mutual Termination is so Often the Key.

I will next month be putting on a webcast on April 18 on Employment Law for Female Workers in China. Do not miss it!

China lawyersPractically every month one of my firm’s China lawyers will get an email or a phone call from someone who bought an expensive chemical from a Chinese company only to receive baking powder. One very savvy chemical industry client once told me that “more than 95% of the China companies selling chemicals online are fraudsters and many of these companies are not really even in China.” I have no doubt that this person was exagerating for effect, but another such person I know insists that the percentage does scrape 50 percent. But all this is old news and if you want to read an in-depth post we did on one particular such scam go to Anatomy Of A China Scam. Just The Facts.

What is also old news is how there is a long history of Chinese fishing companies (much fewer than 95%, that I know) sending over large amounts of spoiled fish and then claiming the fish went bad en route due to no fault of theirs.

But here’s the “new news”: the sending of “junk” instead of real product has spread to pretty much every industry in China and ordering your products from reputable online sites provides little to no protection. Our China attorneys have consistently found that ordering products from a Chinese manufacturer listed on a site that claims to screen its vendors or claims to provide you with recourse provides little to no added protection.

The below email (modified so as not to reveal anyone) is 100% par for this new course:

Hello, Not sure what to do here with my situation, I’m very flustered here. I worked with a reputable company in China to manufacture window awnings [I made this up] on which I have a U.S. patent pending and also have trademarked.  I received samples from them and all was good. I placed an order for 5000 pieces and they are of the wrong material, warped and the sections that are supposed to open freely do not operate correctly because of the wrong material. I spent hundreds of thousands on this order and now they will not get back to me. They told me they were going to rework the products because they knew there was an issue. Now I have all this product that is useless that I cannot sell and I am paying storage on all of it because I am hoping still to be able to return it. I did use ______________ to find them and but it seems they cannot do much to help me. I’m out so much money and yet still trying to get a new product to market but that is proving really difficult because I have been hurt so badly financially. Can you help.

My response to these sort of emails is usually very short and it consists of my explaining that the odds are overwhelming that we cannot help them and that they should think long and hard before throwing good money after bad. I then mention something along the lines of how they should not order from China again without doing a lot of things differently than the first time.

But here I can say a more about why this sort of thing happens and what you can do to prevent it from happening to you.

  • These things happen because the buyer does not conduct due diligence on the seller. It is that simple. I swear, half the time when I get an email like the above and I spend 2 minutes searching out the Chinese company on the internet I find multiple instances of fraud committed by the same Chinese company.
  • Almost always the Chinese company that committed the fraud does not really exist. In other words, it is not registered anywhere in China or if it is registered as a real company in China it is registered for something like plumbing repairs, not for manufacturing window awnings.
  • These fraudsters are smart and there are good reasons why they spend the money to send you something instead of nothing at all and why they at first claim they will remedy the problems and why they so often continue to make that claim. The reasons are usually two-fold. One, sending even really bad product is less likely to lead to criminal charges than sending no product at all. If the police come by the Chinese fraudster can say, “I sent them the product they ordered. It’s not my fault those Americans/Europeans/Australians are so picky.” Two, by stalling they can keep their scam alive for much longer. They’ve paid for advertising and for a website and they’ve even bought the really bad product (be it spoiled fish, baking powder or bottom of the line window awnings) and they want to maximize these expenditures
  • Be careful when establishing business relationships with a new company. Do as much due diligence as you can. Send people you trust to do a site investigation of the manufacturing site.  Do a site inspection on goods before payment. Make sure the company exists and is legally able to conduct the business for which you will be paying it.
  • Use a contract that actually works for China and that sets forth clearly what you are buying and what happens if your China supplier fails to comply. See China Contracts: Make Them Enforceable Or Don’t Bother and China Contracts that Work.
  • Know the market price of whatever it is you are seeking to purchase before you purchase it. Do not trust a company that gives you unreasonably low price quote.
  • Consider a small trial order to reduce your risk. The problem with this though is that many scammers will provide you with a good trial and then scam you when you order the full amount. But if you combine this with a contract that works for China and proof that the company actually exists and is operating legally, you will be lowering your risks.

One more thing that warrants its own special mention. Do not buy product from China without first registering your trademark in China because many of the fraudsters that are sending out bad product are now also registering YOUR brand name and/or product name and/or logo in China as THEIR trademarks in China and then coming back later seeking to sell you these trademarks (for a lot of money) under threat of blocking your products from leaving China for violating THEIR trademarks. See 8 Reasons to Register Your Trademarks in China. We do not have concerte proof that it is the same people both times but it has happened far too often for me to ascribe it to coincidence.

An ounce of prevention is worth a pound of cure.