China WFOE formation

I do mean to sound alarmist here.

Almost since this blog’s inception, we have written about how if you are doing business in China you need a Chinese legal entity, be it a Wholly Foreign Owned Entity (WFOE), a Joint Venture (JV) or a Representative Office (RO). And pretty much each time, our writings on this get more emphatic and more strident. Today they reach a whole new level. Today we warn you about jail time because that is what we are hearing is happening in China right now.

In the last two years our stridency on this issue has gone into hyperdrive. Today I want to SCREAM that if you are doing business in China without a Chinese legal entity you should probably leave China immediately and consider what to do in China from the safety of your own country.  I will explain why I am saying this shortly.

In March of 2017, in Doing Business in China with Deportation or Worse Hanging Over Your Head, I had the following to say:

We have frequently been writing of late on how China has like never before been tracking down foreign companies (especially U.S. companies) that are operating in China without having a business entity (a WFOE or a Joint Venture) that allows them to legally do so. See Donald Trump and Your China Business: Double Down, Ditch It or Die and Donald Trump and Your China Business: Double Down, Ditch It or Die, Part 2. In China’s defense (not that its decision to rigorously enforce its own laws needs any defense), the new WFOE formation rules enacted last year do actually make it somewhat faster, cheaper and easier to form a WFOE.

Anyway, since we started hitting this issue hard here on the blog, we have gotten an even greater stream of emails from people who have been “caught” by the Chinese government and from people who want to know what exactly they need to do to get legal. But the most interesting emails come from those who either fully or partially refuse to believe what has been happening in China and how at risk they are. About half of the emails sent to our China lawyers evidence at least some aspect of this and about half of those mention forming a company in Hong Kong as an option for solving all problems.

So let me say right here and right now that forming a company in Hong Kong will not do a thing to make you legal in Mainland China. Nor will forming a company in Macau or Taiwan or Singapore. If you are doing business in the PRC/Mainland China, you need a PRC legal entity, such as a WFOE or a Joint Venture. See Having A Hong Kong Business Does NOT Make You Legal in Mainland China. See also A Hong Kong Company Is NOT a Mainland China Company and a Hong Kong Trademark is NOT a Mainland China Trademark. If it were otherwise, virtually nobody would go through the agony and the costs of forming a WFOE; they would instead pay some accountant in Hong Kong about USD$1,000 and have an HK company in less than a week. Please, please, please do not fool yourself into believing otherwise!

The below email is an amalgamation of two emails I received just this morning, both involving people with United States and Taiwan passports.

I came across your law blog and would like to ask a question. I’m in a slightly strange situation, professionally and nationality wise, and I I wonder if you might be able to offer me guidance.

I am a US/Taiwan dual national living and working as a freelancer in Shanghai, which is my base. I work in the _________ business on a contract-to-contract basis. Though my Taiwanese friends are always telling me not to worry about things like taxes, the more established and successful I become, the more I think I should be figuring out how to get legal in China and make myself legitimate, business-wise.

I am a ________________ and I do other related things. For example, I’ve just been asked to __________ on a relatively large project. Sometimes I am paid in RMB and other times I am wired foreign currency to accounts I hold overseas. Sometimes because I am not a legal business the companies I work for negotiate discount rates from me because my not having a China company precludes them from getting a tax deduction for their payments to me.

As I progress professionally, the amounts I charge and get paid keep increasing and I worry about what all of this means for the long term.

A friend has suggested I go to Hong Kong to set up a WFOE. However, I know some of the rules are different for Taiwanese nationals who wish to set up businesses in China.

It is not my ambition to have a big company or service but I also know that this gray area situation may not be sustainable forever. I also want to know if any of this might affect me as a U.S. citizen. At the moment, I just file federal taxes online.

Please let me know if you have encountered cases such as my own, and if you might be able to point me to resources that would enable me to best formalize my situation.

Many thanks.

Our response is always something like the following:

Setting up a company in Hong Kong will not help you one bit in terms of getting legal in China. You need to re-think what you are doing because as you get bigger you become a bigger target. I do not know how China treats Taiwan citizens, but if you are an ethnic Chinese there on a US passport, you are probably at the top of the list. My advice is that you start doing something and fast. You should consider either leaving China or setting up a WFOE in China that employs you. If you leave China you can do some business in China without triggering the need to have a WFOE in China, but because you provide services there, you will still be required to pay income tax there. So long as you are paying your United States taxes, the U.S. very likely does not care what you are doing or where you are doing it; your big concern should be the PRC, especially since you live there. The bigger you get, the more likely it is that someone will rat you out or that you will be noticed by the Chinese government. Productive legitimate businesses do not operate with this sort of hammer poised to hit them on the head. What you should do is weigh the various costs and benefits of your various alternatives and decide on one.

Then just last month, in American Companies in China without a WFOE and the Impact of Donald Trump and US Tariffs and Why Hong Kong is not the Answer I wrote again how American companies are at increased risk of serious trouble for operating in China without a WFOE:

If you are an American company doing business in China, you don’t need me to tell you how so many things have changed for you over the last year or so, and so I won’t.

But I do need to tell you — somewhat urgently — that if you are operating in China without a legal Chinese entity, you need to stop. Like right now.

Back in March, we did a post, Doing Business in China with Deportation or Worse Hanging Over Your Head in which we discussed how “China has like never before been tracking down foreign companies (especially U.S. companies) that are operating in China without having a business entity (a WFOE or a Joint Venture) that allows them to legally do so. See also Donald Trump and Your China Business: Double Down, Ditch It or Die and Donald Trump and Your China Business: Double Down, Ditch It or Die, Part 2. Our thesis — based on what we were seeing on the WFOE front and on other crackdowns involving even things like bar fightsvisasexpat taxescannabis, and employment law — was that China was toughening up enforcement against foreigners and foreign companies in China on all fronts, but especially against Americans and American companies as a sort of a slow and not terribly public retaliation against President Trump.

With all the talk now about US tariffs against China, legal enforcement in China against American companies operating in China without a WFOE has gone into hyperdrive. One of our readers, herself a China lawyer, recently wrote me to let me know how ridiculous she thought I was for believing Beijing would “quietly” go after American companies. My response to her was that we had no idea whether China’s stepped up legal enforcement is being directed from Beijing or is more in the nature of a slow and quiet and yet widespread uprising against the United States being mounted by government officials throughout China.

We can debate who is leading this enforcement charge and even the reasons for it, but to me the most important thing is that if you are an American company and you are not in full compliance with Chinese law you are at greater risk now than you have ever been. If you are doing business in China, especially if you are doing business there “through” a Chinese citizen you are paying, you need to think long and hard about your China company formation options.

Whenever we write about how China is getting tougher with such and such a law, we invariably get emails and/or comments saying how idiotic and/or unfair we are for criticizing China for enforcing its laws. Just so the record is clear, we have not said that and we are not saying that; we are as neutrally as possible merely writing on what we are seeing and we would be more than happy to leave it to the legal philosophers to put these sort of real-life China business and legal issues into some larger context.

In addition to the stepped up enforcement of China’s WFOE requirements, we are also seeing a massive uptick in American companies forming Hong Kong Companies or consulting WFOEs in ill-advised efforts to get legal. So let me use this blog post to once again make clear, forming a company in Hong Kong does not do a thing to make your business operations legal in Mainland China:

Nor will forming a company in Macau or Taiwan or Singapore. If you are doing business in the PRC/Mainland China, you need a PRC legal entity, such as a WFOE or a Joint Venture. See Having A Hong Kong Business Does NOT Make You Legal in Mainland China. See also A Hong Kong Company Is NOT a Mainland China Company and a Hong Kong Trademark is NOT a Mainland China Trademark. If it were otherwise, virtually nobody would go through the agony and the costs of forming a WFOE; they would instead pay some accountant in Hong Kong about USD$1,000 and have an HK company in less than a week. Please, please, please do not fool yourself into believing otherwise!

In fact, the more you get on the grid in China without actually doing everything the right way in China, the more you make your illegality more obvious and easier to spot. See Quasi-Legal In China. Not the Place You Want to Be andQuasi-Legal in China. Not the Place You Want to Be, Part II.

We are also hearing from many American (and some European companies as well, but we’ll save that for a subsequent post) companies that formed their WFOE in China the “fast and easy way.” Some less than reputable WFOE formation companies will tout how they can form China WFOEs quickly and cheaply and for only around USD $15,000 in minimum capital. What these WFOE formation companies typically then do is form your company as a consulting WFOE in an “easy” China city. Please don’t fall for this. If your WFOE is not going to be in the consulting business, it cannot legally operate as a WFOE in China and it will get shut down. See How To Form a China WFOE. Scope Really Really Matters, Part II. And if your WFOE is going to be operating in Xi’an you do not want it to be formed in Shenzhen, for just a whole host of reasons.

If you are not complying with Chinese laws it is important you move quickly to get into compliance. But it is also important that in moving quickly you not expose yourself to even more and potentially greater problems. To borrow from a famous legal quote, you should move to get legal in China with all deliberate speed.

China company formation done wrong is not going to be your answer.

Today I write to say that things have reached another level for people of all nationalities doing business in China without a legal entity. Today I write to say that doing this — whatever your nationality, puts you at extreme risk of being arrested and put in jail. I cannot go into much detail but I can tell you that over just the last three days I have heard of three instances (in three different Chinese cities) where foreigners (from three different countries) were put in jail for operating in China without a business license and failing to pay taxes on their China income. Jail. Prison. The clink. The slammer. The real thing people. The real thing. One of these cases also involves vague allegations of custom violations, claims for which the Chinese government has never been shy about imprisoning foreigners. See China Customs Violations and How to Avoid Jail Time.

Why are these arrests happening now? I posit the following two explanations:

  1. The arrests are happening because China is concerned about its economy and/or its general situation in light of US trade tariffs.
  2. The arrests are happening as just another “stepping up” of China tax collection efforts.

Again though, these arrests are not just of Americans. It is so early in the criminal law process that it is not clear to me how serious these charges are against those arrested. Will they merely be deported? Have they been arrested with the goal of getting evidence against others? What is it going to take for these people to be freed? Will paying off their taxes with interest and penalties be enough to get them released? See China’s Tax Authorities Want You. Will paying some part of the taxes be enough to get them released? What taxes are being pursued? Income taxes? Employer taxes? Both? Most importantly, is China serious about putting these people in jail for an extended period and if so, for how long.

No matter what the reasons for this most recent and most alarming crackdown, if you are in China right now and if you believe you or your company might be operating in China without a Chinese company when you should have a Chinese company, if I were you I would leave China quickly. I just would. And if you do get detained on your way out, you should as quickly as you possibly can retain a top-tier Chinese criminal lawyer in the city in which you arrested.

That is all. Sorry.

 

UPDATE: A loyal reader emailed me to note how this is the second day in a row that we have warned people not to do something at risk of going to jail. Yesterday, in China Tariffs and What to do Now, Part 1, I passed on advice from my law firm’s international trade lawyers regarding the criminal risks relating to changing the country of origin via transshipping to avoid the tariffs the US is imposing on products from China. This reader pointed out how the devolution of free trade is increasing the risks for companies that operate internationally. I agree with that assessment, but note that it is particularly true for those who are not careful and who are willing to operate close to the line between legal and illegal. Your thoughts?

ADDITIONAL UPDATE:  A Chinese lawyer friend of mine sent me an email stating that “the point here is that operating in China without a WFOE is illegal. This also applies to Internet/SaaS operations operating in China illegally, and you and I both know plenty of those. So long as the operators of these illegal Internet/SaaS operations stay out of China, they will avoid jail. But what about their partners who are operating in China? And what about when they take a two week business trip to China to check up on the situation there? Do you think companies really understand the fire they are playing with here?”

Transshipping from China International Trade Lawyers
Don’t transship. Just don’t.

Not surprisingly, our China lawyers are getting a slew of phone calls and emails from companies that are looking at massive tariffs being imposed on their products imported into the United States. These companies want to know what they can and should do now to ameliorate or avoid their tariff problems. This is the first part in what will no doubt be a constantly ongoing series of posts on what you should be doing in light of the US tariffs being enacted against imports from China.

But before I discuss what companies do about their tariff problems, it is far more important I start out discussing what they should NOT do. They should not have their China products shipped to Taiwan or to Malaysia or to Thailand or Vietnam or anywhere else and then have those products shipped to the United States as though they are not from China. Doing this sort of transshipping can and does lead to massive fines and to JAIL TIME. I am not kidding. I am starting out with a post on what not to do because the risks from this one thing far exceed the benefits of the things we will be discussing in our subsequent posts.

And yet, many are telling us that their Chinese factories are suggesting these exact sort of transshipments and giving assurances that they are legal or that nobody ever gets caught, neither of which are remotely true. Step back for just a second and ask yourself why you are even considering taking legal advice about United States customs law from a Chinese factory owner or salesperson who has all the incentive in the world to sell you Chinese products and very little incentive to keep you out of jail. Please, please, please don’t fall for that. Please.

Chinese companies and the U.S. importers of their products often believe they can get around United States tariffs  by transshipping the products to Malaysia, Vietnam, Philippines, Sri Lanka, Thailand, Bangladesh, India, [or some other country] before sending them on to the United States. Their plan is to relabel the products with a new country of origin and then export the products to the US free of China , without US Customs and Border Protection (“CBP”) ever being the wiser.

So wrong.

US Customs has become expert at discovering such evasions and the penalties when caught have become very harsh. Importers that knowingly falsely label the country of origin on their imports are subject to significant fines and penalties under 19 USC 1592 and to criminal prosecution under 18 USC 542 (import by using false statement) and 18 USC 545 (smuggling). Lying about a product’s country of origin can subject you to 20 years in Federal prison.

Immigration and Customs Enforcement (“ICE”) has conducted criminal investigations against a number of products, including honey, saccharin, citric acid, lined paper products, pasta, polyethylene bags, shrimp, catfish, crayfish, garlic, steel, magnesium, pencils, wooden bedroom furniture, wire clothing hangers, ball bearings and nails. Many of these investigations have led to criminal convictions and large fines and penalties. U.S. importers have also been prosecuted and sentenced to prison for bringing in Chinese products, such as honey, garlic, wooden bedroom furniture and wire clothing hangers, by means of false Country of Origin statements so as to evade US AD and CVD orders. My law firm’s international trade lawyers are always pointing out that whenever the US increases tariffs on a product, it knows there is an increased likelihood of illegal transshipping of that product and it prepares accordingly. There is zero doubt the U.S. government is preparing to catch those who transship China products to avoid the new China tariffs. There is also zero doubt that both the U.S. government (and even the U.S. populace as a whole) are going to be tougher than usual on anyone who engages in transshipping

United States CBP, ICE and the Justice Department can be very tough investigators and prosecutors.

One of the biggest hammers against transshipping is the False Claims Act (“FCA”).  The FCA ( 31 U.S.C. § 3729) allows people or companies to file what are called “qui tamlawsuits against individuals or companies that directly or indirectly defraud the Federal government seeking triple damages on the government’s behalf. Anyone who knows of the fraud, including a competitor company may file a qui tam lawsuit. And they do.

Qui tam actions are brought to attack competitors and to get 15 to 30 percent of the triple damages the U.S. Government can recover from the lawsuit. Your competitors and your importers and your own employees (and even employees of the Chinese company that has assured you that your transshipping is perfectly legal) are the most likely to initiate a qui tam lawsuit against you, but sometimes it is just someone who learned of what you are doing. Because the person or company that brings such an action can be awarded millions and even tens of millions of dollars, the incentive to file is huge. If you want to get a better idea of just how lucrative these lawsuits can be, do a Google search for lawyers looking to take on qui tam lawsuits and look how much they are paying for qui tam keywords.

Qui tam lawsuits are filed confidentially and are not served on the defendants, but on the US Government. The US Government then determines whether to intervene and pursue the action or settle with the defendant(s). If the U.S. Government intervenes, it takes on primary responsibility for the case. If the U.S. Government decides not to intervene, the initial claimant may dismiss the lawsuit or pursue the lawsuit on its own.

What is your duty as the US buyer/importer to make sure the products you are importing are truly from the country listed on the import documents?

The examples below are illustrative.

  • A US importer is told by its Chinese producer/exporter whose products will be covered by the China tariffs not to worry about the tariffs because the Chinese company will ship the product through Taiwan and list them as Taiwan products. The importer should decline this offer because if it imports this product knowing it is from China and not Taiwan, it will be criminally liable under U.S. customs law and subject to potentially massive damages under the U.S. False Claims Act. 
  • A US importer suspects its Vietnamese “producer” is not actually making anything, but rather simply transshipping product that comes from the Chinese company that owns it. The company visits the Vietnam facility and it does not appear anything is actually being produced there. The US importer raises this concern with the Chinese company which tells the US company that it can avoid any problems by being listed as the consignee of the products and not the importer of record since it is the importer who is at risk. This too is simply wrong information.

Transshipment is a crime and Chinese companies and their US importers can have very different interests when it comes to importing product into the United States. The Chinese company wants to ship product to the US above all else and the US importer should above all else want to avoid Customs trouble and avoid liability and stay out of jail. The Trump Administration has made known its desire to vigorously hunt down and prosecute transshipment claims.

If you are doing business with a person or company using transshipments to minimize US customs duties, you could be in very big trouble and you should contact a lawyer immediately. If you are aware of such transshipments by a company with which you are not doing business, you should consider contacting a lawyer to determine whether you might profit from your information.

Here’s the thing though. There is often a lot you can do to legally change the country of origin of your products, but the key here is legally. The other key here is that the rules for figuring out the appropriate country of origin are incredibly complicated and best left to an experienced and qualified lawyer, especially in light of all that is going on between China and the United States these days. Even our China lawyers do not claim to be qualified on this score and, for instance, about all I tell my clients who ask for country of origin help is something like the following:

About all I know is that putting together your electronics product in China and then shipping it to Vietnam for a plastic case to be put on it is not going to do the trick. Beyond this though, you are going to need to consult with our trade and customs lawyers because this is not something we can afford for you to get wrong.

So yes, it may be possible for you to make minor (or major) changes in how you are having your products made so they can legally avoid the China tariffs, but please, please, please tread carefully hear and whatever you do, don’t just go along with what your China factory is telling you to do. It’s your company and your money and your freedom that’s at stake here and this is not something on which you should be messing around and taking advice from anyone whose job it is to do anything but look out for your interests.

Got it?

 

China contract lawyers

The other day I cleaned up and revised the various templates our China lawyers sometimes use to answer frequently asked questions we get from our clients. One of them is on how to send to the Chinese side of a deal the contracts we have drafted. Our standard answer is as follows:

 

It is usually best for you to send this contract to the Chinese side as an already signed sPDF. You achieve two goals by doing it this way. First off, the Chinese side cannot easily modify this without your seeing the modifications they have made. It is not unusual for Chinese companies to sign and return your signed Word document as though they did not make any changes when they actually did. Using a PDF makes this a lot less likely.

Second, your sending them the contract this way is essentially telling them, “please execute this without any changes so that we can move forward quickly.” If you send them a Word document you are all but inviting them to make changes to it.

I note though that in the last few years it has become customary to use a Word documents for China contracts because Chinese companies have started to make a lot of changes to their contracts. This is actually a good thing though because it means they now take their contracts very seriously and that in turn means they realize the courts there have gotten a lot better at enforcing them. All of this means that they don’t typically sign these planning to breach them.

So the current best strategy is for you to send them a signed PDF. Then, if they ask for it in Word format you can and should send them that. Just don’t send the Word document until they ask for it!

 

Your thoughts?

 

China lawyers

Because 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 or phone calls 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 quick general answer and, when it is easy to do so, a link or two to a blog post that provides some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

Companies involved in the cannabis industry will sometimes hear about China being a first-to-file jurisdiction and ask if they should file a trademark application in China for their cannabis products. The short answer is no. Cannabis is illegal in China and those who violate the relevant laws are subject to harsh criminal penalties, including the death penalty.

However, it is possible to use the same workaround as in the U.S., where cannabis is also illegal under federal law: register the mark on products that also have legal uses.

China trademark lawyers
China trademark theft is on the rise

Everything China comes in waves and China trademark “theft” is no different. When we first started this blog way back in 2006, we would get about a call a week from someone — usually a U.S. company — wanting us to sue the Chinese company that was blocking the American company’s product from leaving China. We hated those calls because most of the time about all we could do was suggest they try to buy “their” trademark “back” from the Chinese company that now rightfully owned it.

One of our earliest posts (from January 2006), China Trademark “Theft,” talked of how common these calls were back then.

Though troublesome, the damage from domain name usurpation is typically small, particularly as compared to what can happen if someone hijacks your trade name or trademark in China.  We have seen this happen countless times, mostly to American companies who are unfamiliar with the “first to file” trademark law, as opposed to the U.S., British, and Canadian, “first to use” systems.

Though the media love to publish stories deriding China’s intellectual property protection, those articles frequently fail to mention that in most instances involving trademarks, the fault lies with the foreign (American) company, not with Chinese IP enforcement. The reality is that many foreign companies fail to register their trademarks in China and thus have no real right to complain about any “infringement” there. To expect protection, foreign companies must register their trademarks in China and the prudent company does this before going in.

There are actually a number of people in China who make a living (and a good one at that) by usurping foreign trademarks and then selling a license to that trademark to the original, foreign, license holder. Once one comes to grip with the fact that China, like most of the rest of the world is a “first to file” country, one can understand how easy this usurpation is, and also, how easy it is to prevent it.

The fact that you are manufacturing your product in China just for export does not in any way minimize the need for you to protect your trademark. Once someone registers “your” trademark in China, they have the power to stop your goods at the border and prevent them from leaving China. That’s right, they can stop your goods from leaving because they own the trademark, not you. We are aware of companies having to pay hundreds of thousands of dollars to get their trademark “back” and to get their goods flowing out of China again.

As my firm’s lead China trademark lawyers is always saying: the key to protecting trademarks in China is to register them in China before you do business there. This can usually be done at a relatively small cost. You should also consider getting the Chinese language equivalent as well.

For years we probably averaged a call a week from someone who had lost their trademark to China, to someone who had gone ahead and filed it before the non-Chinese company did so. Then, starting maybe 5 or 6 years ago, the number of these calls declined. I have ascribed this decline to two things. First, American companies started getting wiser about the need to get their brands, their logos and their company names registered as trademarks in China, due in small part to this blog even. Second, and of equal importance, China instituted rules to try to stop Chinese manufacturers and trading companies from registering as trademarks the brand names and logos and company names of the foreign companies for whom they were manufacturing or sourcing products. To simplify a bit, your China agent could not hang on to a China trademark that you were using before you brought them on for your manufacturing or product sourcing. We went from one China trademark “theft” call a week to maybe one a month.
But starting about a year or so ago, our China trademark lawyers started getting a ton of China trademark theft calls and the number of those calls has been accelerating ever since. Why has the tide on trademark “theft” come in again? Two reasons. One, there is hardly a sole in China who does not know how to get around the prohibition on an agent registering the trademark that rightfully should go to the foreign company for whom it is acting as an agent. If your manufacturer in Shenzhen wants to secure “your” trademark in China it will not go off and register it under its name as it knows that cannot work. So instead of registering the trademark under its own Shenzhen company name, it will ask a cousin or a nephew in Xi’an to register it under its company name, making it nearly impossible for you to invalidate the trademark. Two, many (most) Chinese factories are hurting and they desperately want to improve their profit margins. What better way to do so than to sell a product under a prestigious or well-known American brand name — or even just any American brand name? See Your China Factory as your Toughest Competitor.
Our China trademark lawyers have been getting so many trademark theft calls of late that they now have a somewhat formulaic email response to those. The following is an amalgamation of a few that recently crossed my desk.
I am sorry to hear that someone has registered your brand name as its trademark in China. Our China trademark lawyers have handled many similar situations and they usually do not end well.
The first thing we usually do in these situations is figure out some basis for challenging this Chinese company’s trademark filing. Our favorite challenge is non-usage of the trademark for more than three years, but in this case because the trademark is less than three years old, that will not work. Our second favorite is when a former factory does the filing because there are laws against that. But to show that it is the former factory, we almost certainly would need to show that the company that actually filed is the same company that you formerly used for your production and that is seldom possible.
If we are not able to get you the trademark you want for widgets, the next thing we do is try to figure out whether there might be a workaround. For example, we had a lawn equipment company that had its brand name filed as a trademark for 17 things related to lawn equipment but the trademark “thief” failed to file for small engines, like those you find on lawn equipment. So our workaround was to get our client the trademark for small engines and then put its name in steel on the engine and then add a sticker or two to the lawnmowers once they hit the United States and Europe where our client sold its lawn equipment. [NOTE: I changed the type of product to make it impossible to be able to identify the company for whom we did this intellectual property workaround]
If none of the above look like they can succeed, we can and should try to buy your name from this Chinese company. Unfortunately, this tends to be a tougher and, more importantly, a more expensive than you likely would expect. We do these buys by lining up a Chinese person (not a lawyer or anyone with any apparent connection to our law firm) in China to handle the negotiations. If someone from our firm were to call, they would will immediately suspect/know we are working for an American company and they will ask for a fortune for you to get your trademark back. It sometimes even makes sense to form a Hong Kong company to do the buy.
Another possibility would be for you to come up with a new name or use another of your names — I am sure you have thought of this and I doubt that it is appealing to you, but it may end up being the only way to go. No matter how we end up proceeding on the name taken from you, I strongly advice that we look at what we can do now to protect whatever other names you use and perhaps your designs as well.
As for your attorneys who you thought had filed for your trademark in China but had not, do you have anything that would indicate you asked them to do so or that they said they would or — better yet — that they said they had actually filed for it? If you have something like that, we could ask that they fund all of the above, assuming that you used real lawyers for this work. See Fake China Law Firms Are The Real Deal and Is This a Real China Lawyer?
Anyway, let’s talk to see if we can help you on this.
China IP licensing

On August 23 and August 24, Law Seminars International will be putting on An Advanced Conference on Current Dealmaking Trends for IP and Technology Licensing: Tips for efficiently and effectively monetizing intellectual property. 

This event will be live at the Courtyard Marriott in Pioneer Square in Downtown Seattle and also via webinar wherever you are. Go here to get a pdf of the entire program. I will be speaking on the second day regarding “enforceable contracts as a starting point [for IP protection]: Classic pitfalls foreigners fall into when dealing with Chinese entities, like drafting in English, and other key considerations.”

Per the organizers:

Who Should Attend. Attorneys, business executives, licensing professionals, and others involved with complex licensing transactions.

Why You Should Attend.  Licenses are one way of bringing intellectual property to life. Without licenses, IP rights lay dormant until weaponized in court. Licenses allow IP to be commercialized, accessed and harmonized without resorting to aggressive enforcement. In today’s climate of constant change and tighter budgets, the ability to spot, craft, draft and negotiate license agreements efficiently and effectively is more important than ever for licensors and licensees.

This conference provides insights on developing issues arising from drafting and negotiating licenses, updates on case law, changes in technologies that impacts licensing, and the rise of new international players in IP licensing.

Join our distinguished faculty as they address the above and additional licensing issues from both outside counsel and in-house perspectives including a panel on problematic clauses and what to do about them.

What You Will Learn. 

  • ~ The anatomy of an effective license agreement
  • ~ NDAs as the courting phase of the licensing relationship
  • ~ Case law update: Recent cases impacting IP licensing values
  • ~ Assigning and licensing trademarks
  • ~ Biopharmaceutical trends including licensing for joint ventures and as a result of collaborative activities
  • ~ Compulsory licensing, Standard Setting Organizations, and FRAND
  • ~ Managing compliance
  • ~ International licensing with China
  • ~ Provisions for resolving licensing disputes
  • ~ Wrap-up: Mock negotiation of a hypothetical licensing agreement

The seminar will consist of the following:

DAY ONE

Introduction & Overview, 9:00 a.m.

Adam L.K. Philipp, Esq.
AEON Law / Seattle, WA

Ramsey M. Al-Salam, Esq.
Perkins Coie / Seattle, WA

 

The Anatomy of an Effective License Agreement, 9:15 a.m.

Core essential terms, including exclusivity, lump sum versus sales-based royalties, royalty bases and rates, exclusions, standard forms and provisions, warranties, indemnities, audit rights, keeping IP from competitors, “poison pill” provisions

Steve Tapia, Esq. , Distinguished Practitioner in Residence
Seattle University School of Law / Seattle, WA

 

NDAs as the Courting Phase of the Licensing Relationship, 10:30 a.m.

The structure and essential terms of non-disclosure agreements; the “new world” of NDAs and how they affect high tech joint ventures; lessons from the Waymo/Uber dispute about protecting trade secrets

Adam L.K. Philipp, Esq.

 

Case Law Update: Recent Cases Impacting IP Licensing Values, 11;15 a.m.

An update on how recent decisions affect the value of IP rights and the enforceability of licensing agreements

Ramsey M. Al-Salam, Esq. , Program Co-Chair
Perkins Coie / Seattle, WA

 

Assigning and Licensing Trademarks, 1:15 p.m.

The need to transfer good will and police the quality of goods sold under a license; the ability of bankrupt licensors to extinguish licensee rights and the impact on pre-bankruptcy negotiations when relations are strained; unique cannabis issues

Jerry A. Riedinger, Esq.
Perkins Coie / Seattle, WA

 

Biopharmaceutical Licensing, 2:00 p.m.

Transactional trends including licensing for joint ventures and as a result of collaborative activities

Gary M. Myles, Esq. , President & CEO
Myles Intellectual Property Law / Issaquah, WA

 

Managing IP Compliance, 3:00 p.m.

Structuring an effective process for counting royalties, tracking work product, regulatory compliance, patent marking, trademark quality control, audit rights, verifying “best efforts”, “most favored” clauses, and anticipating other issues

Neil Zoltowski , Principal
StoneTurn Group / San Francisco, CA

 

Compulsory Licensing, Standard Setting Organizations, and FRAND, 4:15 p.m.

When you have no choice: Where compulsory licensing comes into play including when it’s “necessary” to practice a standard

T. Andrew Culbert, Esq.
Perkins Coie / Seattle, WA

 

Continue the Exchange of Ideas: Reception for Faculty and Attendees, 5:00 p.m.

 

DAY TWO

International Licensing: Adapting to Recent Developments in China, 9:00 a.m.

An enforceable contract as a starting point: Classic pitfalls foreigners fall into when dealing with Chinese entities, like drafting in English, and other key considerations

Daniel P. Harris, Esq.
Harris Bricken / Seattle, WA

New rules on IP transfers; importing & exporting technology; potential impacts from recent trade negotiation; IP enforcement statutory changes, administrative enforcement, and increased damages awarded by courts

Ping Gu, Esq.
Zhong Lun Law Firm / Beijing, China

 

Provisions for Resolving Licensing Disputes, 10:30 a.m.

Choice of resolution technique in the license and choice of technique when enforcing the license: substantive and procedural considerations for choice of law; mediation and arbitration clauses; enforcement stage choice of forum

Mark Wittow, Esq.
K&L Gates / Seattle, WA

 

Wrap-Up: Mock Negotiation of a Hypothetical Licensing Agreement, 11:15 a.m.

Identifying what is most important to your opponent; provisions to tailor the agreement to the type of license and situation; anticipating potential problems from changes in control and adverse events; tips for working through problematic provisions

Steven B. Winters, Esq. , Moderator
Lane Powell / Seattle, WA

Licensee perspective

Jeff Harmes, Esq.
Karcher Harmes / Bainbridge Island, WA

Licensor perspective

Hillery L. Nye, Esq. , General Counsel
Zipwhip / Seattle, WA

I know or know of many of these attorneys and I am very much looking forward to hearing their talks and I urge anyone with an interest in IP go here and sign up. If you use HARRIS as your promo code, you will get a 50% discount.

China contract lawyersEarlier this year, in China and Worldwide: Trademarks Good, Patents Bad, I wrote about how patents are overrated as compared to trademarks.

I cannot tell you how many times I’ve had companies swoon over the idea of spending big money to secure a patent and pooh-pooh my suggestion to spend small money to secure a trademark. Honestly, most of these companies don’t really get it.

I went on to write about how patents are usually expensive to get and expensive to protect whereas trademarks are relatively inexpensive to get and inexpensive to protect.

I then talked about how if sending a cease and desist letter to try to get someone to stop violating your patent usually results in their claiming there is no violation. I then mentioned how if you go to the e-commerce sites on which the alleged patent infringer is selling your product — even if that product almost certainly does infringe your patent — and you ask that e-commerce site to take down the infringing product, the odds are good that site will tell you they are not patent lawyers and you will need a court order or a judgment for them to take it down.

All of this means that if you want to stop your competitor from selling what infringes on your patent you must sue and you likely will need to hire an expensive expert to prove the infringement. Few things in life cost more than international patent litigation, and since my law firm does international patent litigation, I know whereof I speak on this.

I then wrote about why trademarks are simpler and cheaper:

  1. Securing a trademark typically costs 1/3 to 1/4 less to secure than a patent. This is true pretty much everywhere.
  2. If you believe someone is violating your trademark and you send them a cease and desist letter to get them to stop doing so, there is a decent chance they will stop, especially if they are not in the counterfeiting business.
  3. If you go to e-commerce sites and request the product infringing on  your trademark be taken down (and it is in fact violating your registered trademark), there is a very good chance it will be taken down. This is generally true of the leading e-commerce sites around the world. It does NOT take a lawyer to know that if I have a registered trademark in China and the United States for “Harris Special Orthopedic Device” (in the right class), anyone else selling “Harris Special Orthopedic Device” in China or the United States (that did not come from me) is violating my trademark. My law firm’s success rate in taking down offending trademarks is super high. Like 99+ percent high.
  4. Should you choose to sue for a trademark violation, proving the trademark violation is oftentimes relatively easy.

All of the above are also why contracts are another key to protecting your IP from China.

Let me explain.

As we have written here so many times, your scariest competitor is your own supplier. See Your China Factory as your Toughest Competitor. Chinese factories will apply what they have learned from making your products and use that information to compete directly with you. My firm’s China lawyers are fond of pointing out to our clients, “since you will essentially be educating your Chinese manufacturer in how to compete with you, you need contracts that will at least limit what it can do when it does so.” And if you believe it does not make economic sense for your China factory to sell your product directly, let me tell you that our China lawyers have seen so many cases where this has happened that we know it often does:

We have gotten more calls in the last year from companies whose China factories are now directly competing with them than in probably the three years before that combined. Chinese factories are more confident now than they have ever been about going out into the world with their own products, and more willing to toss their foreign customers to the curb early. E-commerce sites do not help matters and the US-China tariff war has been like throwing accelerant on the problem. The US company tells its China supplier that it needs lower prices to make up for the tariffs and the Chinese company — usually surreptitiously — then starts competing directly with its US buyer to make up for its falling margins.

Far too often our clients believe they are protected from their Chinese manufacturer if they get patent protection in all of the markets in which they sell their products (usually this means some combination of the US, Canada, Australia, Europe, Japan, Korea, Mexico and Brazil) since their patents will prevent their Chinese manufacturer from being able to sell into those markets using the client’s IP. Legally, this is correct, but practically, patent lawsuits to stop patent violations are incredibly expensive and time consuming. Do you really want to be embroiled in simultaneous patent litigation in Spain, Japan and Brazil?

In addition, where product development takes place, there is usually an innovation or improvement your Chinese supplier will claim gives them independent rights in the improved product. Since the Chinese side does the work, they are often correct about this, particularly under the civil law patent approach which allows for minimal innovation as the basis for an independent patent claim.

well written contract with your Chinese manufacturer that makes clear that your manufacturer cannot copy your product (beware: these provisions are not easy to write) and makes clear that a breach will lead to real-life and enforceable consequences can give you massive and far-reaching and low cost protection. To the point that your manufacturing contract will likely be more valuable for protecting you even in those countries in which you have a patent,

A well-crafted manufacturing contract also has another powerful benefit that your patents in the US, Canada, Australia, Europe, Japan, Korea, Mexico and Brazil lack: your contract can work worldwide. So yes, getting expensive patents in these places is great, but they do not give you protection in India or Indonesia or Peru or New Zealand, etc., whereas your manufacturing agreement with your Chinese manufacturer can.

So though patent protections can be valuable, they are not the end-all for China or the rest of the world, by any means. Protecting your product against counterfeiting requires a holistic approach tailored to your specific product and situation, usually involving some combination of patents, trademarks, and contracts and more.

For more on the sort of contracts you can use to protect yourself from China counterfeiting, check out the following:

China employment lawyersWhen our employer clients seek our counsel on new China employee hires, we usually (but not always) advise they use an initial fixed term of three years. We also recommend that before the initial employment term is up, they consider whether to extend the employee’s contract for a second employment term. Because China is not an employment at will jurisdiction and terminating a China employee is generally very difficult, you as the employer should be sure not to take an employee beyond an initial term unless you are certain you wish to continue employing that person. If you choose not to renew an employee for a second term you can terminate the employment but you will have to pay severance based on the employee’s years of service for not renewing the contract. This holds true unless you have a legal/contractual basis for terminating the employee without severance, such as an employee’s serious wrongdoing.

Consider this hypothetical. Employer and Employee enter into an employment contract for an initial fixed term. Both before and shortly after the expiration of the initial term, Employer provides Employee with notices that it wishes to renew the contract and each time Employee fails to sign a new contract. Employee then files a labor arbitration claim, demanding statutory severance for the termination. Will Employee prevail? The short answer is that it depends.

In the real case on which this hypothetical is based, the court (the case went from labor arbitration to the court level) noted that 1) Employer provided convincing evidence, including minutes of conversations between the parties and witness testimony, that showed Employer truly intended to renew Employee’s initial contract and 2) Employee failed to produce any evidence to show Employer’s proposed terms and conditions were worse than the terms and conditions in Employee’s initial contract. The court went on to rule that Employer was not obligated to pay statutory severance upon termination because the applicable law stipulates an employer must pay an employee statutory severance for not renewing a contract, unless the employer has offered the employee the same or better terms and conditions for the renewal and the employee does not agree to renew on such proposed terms.

What are the key takeaways from this? First, you as the employer should start thinking about whether to renew an employee’s contract before that employee’s employment term expires. I cannot tell you how many times our China employment lawyers get called by China employer’s asking us what to do with an employee’s contract that expires tomorrow or expired last week — NOT good. Next, regardless of whether you wish to renew or end the employment, you must provide the employee with a written notice of such intent before the end of the employee’s contract term. If you do not want to continue employing the employee, pay the employee statutory severance and process the employee separation in a timely manner. Avoid putting the employee on another probation to see if maybe things will work out this time. If you want the employee to continue working for you but the employee does not wish to renew (assuming the terms and conditions in the proposed new contract are the same or better than the first contract), document that in writing and process the employee separation. In this situation, you don’t have to pay statutory severance since essentially it is the employee terminating the employment.

If the employee is ambiguous as to what he or she wants, do not have the employee work beyond the last date of his or her contract. In other words, you should not have the employee work without a current written contract. This is because China’s employment laws require an employer use a (current) written employment contract with its employees. Even if you signed a first written contract with that employee but since that contract has expired, you likely will be treated as having no contract at all and subject to all the problems and penalties that go with this.

Under China’s written employment laws, an employee is entitled to an open-term contract after two consecutive fixed-terms. However, in practice, in most places in China, once an employee has been renewed at the end of the initial fixed term, that employee has become an open-term employee, which means he or she must be retained as an employee until his or her mandatory retirement age. Therefore, the first renewal should be treated seriously and no employee should be taken beyond the first term unless you want to see the employee on your team long-term. Like forever long term.

Have employees who are approaching the end of their contract terms? NOW is the time to get on it.

 

 

China Lawyers Manufacturing AgreementsChina manufacturing contracts are very different from Western manufacturing contracts, for a whole host of reasons, most of which stem from either differences in laws or differences in economics. This means our China lawyers often must explain why they are doing something in a China manufacturing so different from the way the client “always does it” in the West. One of the more complicated things our China lawyers often must explain is how we usually handle product liability insurance in our China contracts.

 

The below is an amalgamation of about a half dozen emails our China lawyers have written to explain product liability protections in China manufacturing agreements.

The only real way to cover yourself for liability arising from the use of your product in the United States is to obtain insurance in your own name for all applicable risks. Such insurance is expensive, but there is no practical alternative.

We draft our contract manufacturing agreements with China so that the Chinese factory is liable for damages caused caused by defects in your product, including losses incurred due to products liability claims and losses resulting from government mandated product recalls. We provide this to show to the Chinese side that you are serious about getting a product freed from defects. As a practical matter, however, you are very unlikely to have any success in trying to force the Chinese factory to fund your product liability defense or your product recall in the U.S. The odds of your getting a litigation judgment or arbitration award in China against the Chinese factory for reimbursement of a U.S. based products/consumer liability award or government mandated recall costs are also mighty slim. Typically, the most you can expect is a credit on future purchases. Chinese courts (like most foreign courts) believe the U.S. consumer products liability system is fundamentally unfair and they will not support claims based on damages awarded in the U.S. resulting from such claims. The same is true for U.S. government mandated product recalls. Repair or replace or a compensating credit is usually the most that can be obtained, and you will probably need to work pretty hard to get that. So though we include the language, it does not provide much real protection. Your own insurance is what is required. 

2. Few Chinese factories either carry or will not carry insurance for matters that occur in the United States. Most Chinese factories simply refuse to consider the issue. Other factories will say: you obtain the insurance in the United States. But hey, if you want us to pay the premium, let us know the amount. We will then increase the cost of your product to cover the cost of the insurance premium.

The basic point from the Chinese side is that the China price is low because factories in China take no liability for what happens in the United States (or Europe or Canada or Australia, etc.) except for the standard repair and replace warranty for manufacturing defects. That is part of the China price. If you want to load all of the U.S. liability on the Chinese factory, the price will end up being close to or the same as the U.S. price. So the exercise makes no sense.

We have had clients that, for various legitimate reasons, nonetheless wanted their China manufacturer to sign a contract that required the Chinese manufacturer to buy and maintain an insurance policy that covered the products for product liability claims.

Most Chinese manufacturers refused to sign. This then delays execution of your contract manufacturing agreement.

Many of the Chinese manufacturers that did simply ignored the provisions, stating quite accurately that such insurance is nearly impossible to get in China at any price. The American companies for the most part would then ignore the fact that their Chinese manufacturer had failed to secure the required insurance.

The problem with this though is that if you include provisions in your China manufacturing contract that you will later ignore, you weaken the entire agreement. It suggests you will ignore other provisions both to your manufacturer and to a court. So this is not a good idea. For any China contract, it is best that you include in the agreement only matters that you will take a hard line on and enforce. Loose, we will think about it, maybe we will do it language does not work in China. Clear, simple, blunt is the best way to write for Chinese contracts. If you allow a Chinese manufacturer to be flexible, it will most of the time use that flexibility against you. If you require a Chinese judge to think, the judge will likely give up and deny your claim.

Most insurers have standard language they like to force on everyone and that standard language rarely works for China. We can include that language but it may mean the Chinese side will reject your entire agreement? Or maybe they will sign, knowing they will ignore it later? 

China tariffs vaping industry
Is the clock ticking on the vaping industry?

Like so many other U.S. industries, the U.S. vaping industry is now in the crosshairs of a 25% tariff on products imported from China. The first two waves of President Trump’s proposed tariffs against China covered about $50 billion worth of Chinese products but they did not include any vaping products. After China retaliated and proposed its own equivalent tariffs on an estimated $50 billion worth of U.S. products imported into China, President Trump proposed a much bigger third list of China products to cover an additional $200 billion in imports from China.  This third list targets vaping devices, vaping parts, and batteries from China. Because our law firm represents a large number of companies involved in various aspects of the vaping industry we are hearing a handful about how these tariffs will “decimate” this nascent industry.

The U.S. vaping industry is indeed particularly exposed to these tariffs. Though much of the e-liquid used for vaping is made in the United States, almost all of the vaping hardware is imported from China. Just as Gillette makes the most money selling razor cartridges and not razors, many U.S. vaping companies chose to focus on the higher margin e-liquids, rather than lower margin vaping devices. Some have noted that there are no U.S. companies that produce any vaping hardware products. We are hearing of how many vape shops will be unwilling or unable to pay the extra 25% tariffs because they do not believe they will be able to pass these extra costs on to their customers. If this does prove true, the vaping industry will indeed be decimated.

Fortunately, there is still time for vaping companies to seek a tariff exemption for certain vaping products. The U.S. Trade Representative will accept comments until September 6 on whether entire categories of products listed on the third wave of proposed tariffs — the $200 billion in imports from China — should be exempted. There likely will be yet another chance to make more product-specific exclusion requests later in the fall.

For an exclusion request to have any realistic chance at being granted, vaping companies should address the following factors:

  • A description of the physical characteristics (dimensions, material composition, etc.) of the particular vaping products and the 10 digit subheading of the HTSUS tariff category applicable to those products.
  • Whether the particular vaping product is available only from China. In addressing this factor, requesters should address specifically whether the particular vaping product and/or a comparable product is available from sources in the United States and/or in third countries.
  • Whether imposition of additional duties on the particular vaping product would cause severe economic harm to the requester or other U.S. interests.
  • Whether the particular vaping product is strategically important or related to “Made in China 2025” or other Chinese industrial programs.
  • Requesters must provide the annual quantity and value of the Chinese-origin product the requester purchased in each of the last three years. If precise annual quantity and value information are not available, USTR will accept an estimate with justification.
  • Requesters may also provide any other information or data they consider relevant to evaluating their request.

The process for reviewing and deciding on these exclusion requests will not result in any immediate decision but the hope is that a favorable decision eventually will allow for refunding the tariffs paid.

The goal is to have the USTR review the comments and grant exclusions, particularly for products that are not made in the United States and can only be sourced from China. The last time similar tariffs were applied on steel products back in the early 2000s, many exclusions were granted that helped ease the impact of the tariffs on downstream users.

There have already been many opposing comments and exclusion requests submitted for the first two waves of proposed China tariffs. Many of the opposing comments have noted how the proposed tariffs on the Chinese products have nothing to do with  Chinese practices of stealing or extorting intellectual property from U.S companies, which are the reasons claimed for invoking the China tariffs in the first place. Many have also objected to how these tariffs are not likely to change how China respects intellectual property  rights, but will have a catastrophic effect on certain American companies.  What was a booming U.S. vaping industry now faces going bust with the proposed tariffs. If you are in the vaping industry, now is the time to do what you can to prevent this.

Editor’s Note: The above focuses on the vaping industry but much of it holds true for a whole host of other U.S. industries caught up in the tariffs as well. The bottom line is that the situation for products and companies that will be hurt by these tariffs is not good and the chances of overturning the tariffs are in most cases less than 50 percent. But in many cases the situation is not yet hopeless and it behooves you to try.