China Manufacturing Contracts

China manufacturing has gotten riskier and more difficult. Our China manufacturing lawyers hear this pretty much every single day from our own clients.

On the one hand you have rapidly rising harassment of foreigners going on in China. Not a day goes by anymore without a long media story on the growing xenophobia in China. Example: Less than an hour ago, the New York Times came out with this story: As Coronavirus Fades in China, Nationalism and Xenophobia Flare: Now that the pandemic is raging outside China’s borders, foreigners are being shunned, barred from public spaces and even evicted. These hatreds/xenophobia bleeds into how foreign buyers are viewed and by Chinese factories and all indicators are that this will worsen.

This xenophobia is impacting relations between Chinese manufacturers and its foreign buyers and that alone increases risks. The still ongoing US-China trade war only adds to the problems/risks. Foreign buyers are fleeing China and Chinese factories are reeling from the double whammy of the coronavirus in China crushing their ability to produce and now coronavirus outside China crushing the demand for products.  Chinese factories are scared and desperate and many are on the verge of gong under. Chinese factories that are operating at a loss or believe they soon will be when their customers leave for Vietnam or Mexico or Thailand are dangerous. These are the sorts of factories that cut corners on quality and take their foreign buyer’s IP and compete with them. See Your China Factory as your Toughest Competitor and Chinese Suppliers: Competitors not Friends.

 

China IP Theft is On the Rise

These sorts of factories are the norm in China these days and these sorts of factories see their foreign buyers not so much as long term customers but as marks to be plundered of intellectual property. It is getting really bad out there and our China manufacturing lawyers and IP lawyers are getting more requests for help with “stolen” IP than ever before. Most of the IP problems we are seeing fall into the following two categories:

1. The “Lose Your Product Trap”

Under this scenario, Foreign Company takes its design or its not yet realized product to Chinese Manufacturer and asks if that manufacturer can make it. Chinese  Manufacturer  says it can but it will first have to modify the product to reduce production costs or for some other reason. The product is eventually fully realized and Foreign Company then asks Chinese Manufacturer what it will cost to have the product made. Chinese Manufacturer then quotes a price 2-5 times higher than what anyone else is charging and Foreign Company then calls one of our international manufacturing lawyers for help.

The problem at this point is that Chinese Manufacturer has probably already filed a utility patent or a design patent on the product and is already selling it around the world. Foreign Company often believe what is happening to it can be easily remedied because it is just a cultural or linguistic misunderstanding and our lawyers can use their deep China experience and Chinese language skills to convince Chinese Manufacturer to sign a reasonable contract. This is rarely true and our best advice is that Foreign Company should move its manufacturing to some new country where Chinese Manufacturer does not have patent protection or if this is not possible, we figure out how to work around the patents. Either scenario presents added and unexpected costs for Foreign Company.

2. The Lose Your Trademark Trap

The other common trap we see is when Chinese Manufacturer register’s Foreign Company’s brand name as Chinese Manufacturer’s own trademark in China. Chinese Manufacturer has usually filed for this trademark within a few days of its first initial contact with Foreign Company and once registration of that trademark is complete, Chinese Manufacturer will use its trademark leverage to double or triple its pricing, knowing that Foreign Company cannot use anyone else in China to make its products with its brand name on them without infringing on Chinese Manufacturer’s China trademark.  Chinese Manufacturer is thinking that if it gets the newly doubled or tripled price it will keep manufacturing for Foreign Company, but if it does not get the grossly inflated price, it will start manufacturing Foreign Company’s product in China under Foreign Company’s trademark and sell it around the world itself. In other words, Chinese Manufacturer’s “theft” of Foreign Company’s trademark means it cannot lose.

What’s really changed is that these trademark thefts are happening more and more with existing  customers, not just new ones. The foreign customer will while working with its Chinese manufacturer on a new widget casually mention that widget will be called “XYZ Widget” and then a few months later learn that its Chinese manufacturer applied for the Chinese trademark for “XYZ Widget” two days after learning of that name.

In China Trademark Theft. It’s Baaaaaack in a Big Way, we discussed the recent increase in trademark thefts:

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 soul 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.

 

China Product Quality Problems are Also on the Rise

In China Factory Disputes: The 101, we wrote about product quality and other Chinese factory problems:

Many China factories are in deep trouble due to declining sales stemming from the US-China Cold War. I base this not just on the economic statistics everyone is seeing but also on the fact that our China lawyers are getting a steady stream of emails from foreign companies reporting the usual range of problems whenever China’s factories start suffering.

Our international manufacturing lawyers have been getting a ton of emails from foreign buyers that are being pursued by their Chinese factories for refusing to pay for defective products. Typically the foreign company is trying to achieve some sort of compromise while the Chinese factory is insisting on full payment.

There are a lot of huge risks for foreign companies in these situations, and the typical first question we ask a company in this situation is how easily can they just up and move their manufacturing outside China. If they say they can, then we start working with them to achieve that as quickly as possible. If they cannot, we start talking about the sorts of defenses they need to start building.

 

How to Reduce Your China IP and Quality Control Risks

The best way to reduce the likelihood of having problems with your China product suppliers is to recognize that most manufacturing problems stem from something you the product buyer failed to do to prevent the problem or to reduce its damage were it to occur. This is actually good news in that the power to prevent these problems is in your own hands. See China Factory Problems: Always YOUR Fault?:

The title is somewhat of a stab at humor. It stems from my blaming most (but certainly not all) China factory problems on the foreign buyer. We have written countless times of what is required to secure good product from Chinese factories.

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We have also written how our China lawyers constantly get calls or emails from American and European companies that have received bad product from their Chinese factory suppliers and how there is nothing we can do for them. We wrote about this just last week in How To Get Bad Product From China With No Legal Recourse. To a certain extent, we like being able to blame the victim in these situations because that way we as lawyers can comfortably sit back and tell ourselves that had they only contacted us BEFORE they started having problems, we could have prevented all of their problems.

The below six basic things are key to reducing your China manufacturing risks:

  1. Use a Good Manufacturer.  If you do nothing else that we discuss in this post, do this one thing because it matters as much as all the other factors put together. If you do not know how to find a good manufacturer, pay for someone who does.  At the very minimum, make sure the company you will be using to make your products actually exists and is licensed to engage in the business for which you will be paying it. Even better, do a basic due diligence search on the company to see what sort of capital it has, whether it tends to comply with the law, whether it is always getting sued, etc. Again, if you do not know how to do these things, pay for someone who does. If you cannot afford to do these things, you should not be manufacturing in China. Not anymore anyway. It’s just too risky. Not kidding.
  2. Use Good Manufacturing Agreements. Good contracts will ensure your Chinese manufacturer knows what is required of it and what will happen to it if it does not meet those requirements. For what constitutes a good Chinese Manufacturing Agreements go here. For what constitutes a good China Mold Protection/Mold Ownership Agreement, go here.  For what constitutes a good China NNN Agreement, go here.  For what constitutes a good overseas Product Development Agreement, go here. Well over 90 percent of the China manufacturing contracts we see are worthless because they were written by someone who either does not know manufacturing or does not know Chinese law, or both. Many are worse than using no contract at all. See Why Your NDA is WORSE Than Nothing for China. I cannot tell you how many times a company has come to us with a major problem and said that we had “our domestic lawyer” write this contract for us and so we know it might “have issues” and we have had to tell them that their only possible legal remedy is against the lawyer who wrote their contract.
  3. Use Detailed Documents.  Chinese factories that engage in contract manufacturing tend to do exactly what you tell them to do. This means you need to clearly convey what it is that you want them to do and your instructions and specifications should be detailed and in Chinese. See China OEM Agreements. Why Ours Are In Chinese. Flat Out. Be overly specific.
  4. Visit the Factory. Either your own people or a third party QC company should pay regular visits to your factory. Doing this allows you to make sure your factory understands what it is you want and it also lets them know that you are serious about making sure you get it.  It also humanizes you and tells them know that you really do care about getting what you have told them you want and did not just put these things on paper to look good to your own buyers or to look like you are trying to abide by some law or regulation somewhere. These visits are important.
  5. Inspect Your Products. Perform regular product inspections appropriate to the product you are having made.
  6. Register Your IP. If you have IP worth protecting (and pretty much all of you do), make sure you do absolutely everything you can within reason to protect it both in China and wherever you are selling your products. This means trademarks, patents and/or copyrights. It is usually at least ten times less costly to prevent IP problems before they arise than to try to resolve them after they arise.
If you do all of the above, your chances of having a lose your company sort of problem will go way down. 
I will follow up this post within the next few days by getting into the specifics of what constitutes a “good Chinese contract.”
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Photo of Dan Harris Dan Harris

Dan is a founder of Harris Bricken, an international law firm with lawyers in Los Angeles, Portland, San Francisco, Seattle, China and Spain.

He primarily represents companies doing business in emerging market countries, having spent years building and maintaining a global, professional network. 

Dan is a founder of Harris Bricken, an international law firm with lawyers in Los Angeles, Portland, San Francisco, Seattle, China and Spain.

He primarily represents companies doing business in emerging market countries, having spent years building and maintaining a global, professional network.  His work has been as varied as securing the release of two improperly held helicopters in Papua New Guinea, setting up a legal framework to move slag from Canada to Poland’s interior, overseeing hundreds of litigation and arbitration matters in Korea, helping someone avoid terrorism charges in Japan, and seizing fish product in China to collect on a debt.

He was named as one of only three Washington State Amazing Lawyers in International Law, is AV rated by Martindale-Hubbell Law Directory (its highest rating), is rated 10.0 by AVVO.com (also its highest rating), and is a recognized SuperLawyer.

Dan is a frequent writer and public speaker on doing business in Asia and constantly travels between the United States and Asia. He most commonly speaks on China law issues and is the lead writer of the award winning China Law Blog. Forbes Magazine, Fortune Magazine, the Wall Street Journal, Investors Business Daily, Business Week, The National Law Journal, The Washington Post, The ABA Journal, The Economist, Newsweek, NPR, The New York Times and Inside Counsel have all interviewed Dan regarding various aspects of his international law practice.

Dan is licensed in Washington, Illinois, and Alaska.

In tandem with the international law team at his firm, Dan focuses on setting up/registering companies overseas (via WFOEs, Rep Offices or Joint Ventures), drafting international contracts (NDAs, OEM Agreements, licensing, distribution, etc.), protecting IP (trademarks, trade secrets, copyrights and patents), and overseeing M&A transactions.