Last week, in China NNN Agreements and How to Give Them Real Teeth, I wrote about how you need to put teeth into your China NNN agreements. But what happens when you do? We have found that the use of a properly drafted NNN agreement dramatically reduces infringement by Chinese factories and litigation relating to these issues. Why is that?

The reason is that Chinese companies are truly afraid of the Chinese court system. Chinese companies are not afraid of an order from a Chinese court telling them to behave properly. What they are afraid of is a judgement for a sum certain that will be enforced by a Chinese court by seizing and auctioning their factory assets. What they fear most is a prejudgment seizure of assets that ties up their factory property until the lawsuit is settled. These Chinese companies know that if they breach a well drafted China-centered NNN Agreement, the odds are very high that a Chinese court will order a freeze on their assets and that is the last thing they want.

China NNN Agreements: make sure yours bites.

Due to this fear of the court system, we encounter the following three responses from Chinese factories to our NNN agreements:

First, some Chinese companies will simply refuse to sign. These are the companies that planned to steal the foreign technology from the very beginning. I was recently represented an American company in a very difficult negotiation with a Chinese company on a technology licensing project that involved transferring trade secrets for an industrial process. After unfruitful talks that went on all morning, we reconvened after lunch, at which point the Chinese side announced:  “Look, it is very clear to everyone that the only reason we are interested in this venture is so that we can appropriate the technology of the U.S. company. We have reviewed the documents and it is very clear that he (pointing to me) will not let us do that. So let’s just stop the discussion right here and admit that we have nothing more to discuss.” And that was the end of it.

Some U.S. companies would have seen this as a failure of negotiation. In this case, however the owner of the U.S. company thanked me. He said that his Chinese staff were pushing him into a venture with which he was not comfortable. The confession of actual intent in front of his staff solved the internal problem and prevented his company from making a serious mistake. From this we can see that forcing the hand of the companies that have bad intentions from the start is probably the greatest benefit of a well drafted NNN agreement. I will note though that this sort of situation is quite rare.

Second, some Chinese companies will enter into serious discussion about specific matters they believe should be excluded from the scope of the NNN Agreement. This means they have read the NNN Agreement and they take it seriously, and because they take it seriously they insist that it be modified to reflect their own realities. In some cases, the Chinese company’s concerns are unfounded. But, in other cases, the Chinese company will reveal that they already have technology of their own in the same area that they need to protect.

This is a positive result, for several reasons. First, if the concerns of the Chinese company are unfounded, this provides advance notice that the factory will be unreasonable and difficult to deal with. Second, if the concerns are reasonable, this provides the grounds for more fruitful discussions between the two sides on the technical concerns of each party and these discussions often lead to more fruitful joint development of existing technology. In the past, U.S. companies simply assumed that the Chinese factory was without any technical base of their own. This is no longer true, requiring that the technical base of both sides be considered in any project involving new technology in China.

Third, and most common, the Chinese side will execute the NNN agreement and then treat the three obligations as a serious matter that must be approached with care. How does this work out in practice? It does not mean that every Chinese company will suddenly abandon years of bad practice and suddenly begin behaving well. What it does mean is that when the Chinese factory violates the rules, litigation is usually not required. In most cases, a reference to the NNN agreement and the credible threat of litigation is enough to induce the factory to reform its behavior and step back into line. This is particularly true in cases of disclosure to undisclosed third parties and to attempts at circumvention.

This then illustrates the general approach my firm’s China lawyers take with agreements in China. We do not want to litigate nor do we intend to litigate. Rather, we use the general fear of litigation and involvement with the courts to achieve a result that greatly reduces the likelihood of ever having to go to court. But to be able to reduce the likelihood of having to go to court it is essential that the Chinese side believe that it would be relatively easy for you to sue it and prevail. Most importantly, the Chinese side must believe that you can quickly and easily get a Chinese court to freeze its assets. If the threat of an enforceable money judgement in a Chinese court is not credible, then this strategy does not work. Chinese companies are experts at seeing through threats that are mere bluffs. So the foreign company needs to do it right. Teeth are not enough. You have to make the agreement bite.

For more on China NNN Agreements, I suggest you read the following, in order: