China scams. China attorneys. China lawyers.

Recent business confidences surveys conducted in China show a downturn in the Business Confidence Index for small and medium -sized manufacturing companies of all types, falling to its lowest level since the 2008 financial crisis. The decline in business confidence is the result of features built into the Chinese economy.

This declining BCI shows that economic stress on SME manufacturers in China continues to increase. This is a long term trend, and any resolution of the trade war likely will not impact this general trend. As a result, China based non-government economists are predicting a wave of plant closures and bankruptcies that will ripple through the entire PRC SME manufacturing sector over the next year. The large state owned enterprises will not be significantly impacted; the impact will be primarily center on small and medium enterprises. This means bankruptcy and closures both in the private sector and in the provincial and local state owned manufacturing sector.

These closures and bankruptcies do not reflect the condition of the Chinese economy as a whole. The companies that will be swept away are weak and technologically backward entities that would have been eliminated many years ago in a fully market economy. The Chinese system tends to keep these weak players alive far longer than is economically rational. Then the life support is suddenly removed and they all die at once. This sudden rise in business deaths is what is being predicted for the next decade.

The concern for foreign buyers of Chinese product is that an increase in closures and bankruptcies will also mean an increase in scams and frauds. When a factory in China knows it will be shutting down, its owners often work to make a final score. They set up a deal that allows them to bring in as much cash as possible in the short term. The owners then take the cash as a final bonus, shut down the company and then move on. No bankruptcy is involved. They just shut the doors.

In implementing their scam, the factory owners are faced with a problem. If they commit fraud against another Chinese person or entity, they likely will be pursued for retribution. That retribution may be criminal investigation and prosecution through China’s criminal justice system. Or the retribution may be informal action carried out by an effective criminal gang system active in China.

Perpetrating a scam on a Chinese entity involves considerable risk. On the other hand, scams against foreign buyers have hardly any risk at all. When a foreign buyer is cheated, the Chinese police often do nothing at all and there is virtually nothing your Embassy or Consulate can do beyond put the names of the offenders on a list. The Chinese courts can do little to nothing as well and the informal methods of retribution are rarely available to foreign entities. For this reason, when it comes time to do that last big scam or series of scams before shutting down the factory, foreign buyers will always be the preferred target.

The scams at this stage follow a regular pattern. The three primary patterns are as follows:

Model Scam Number One: It is typical for Chinese factories to require buyers make an initial deposit on the date it accepts the buyer’s purchase order (PO). A common structure for China suppliers is 30% down and 70% paid prior to shipment. Using this structure, a factory that knows it will shut down will take the deposit, do no work at all and simply fail to deliver. If the factory does this with enough foreign customers, it can collect a substantial sum for funding its owner’s retirement.

This kind of scam is hard to detect and for that reason is very effective. The problem for the scammer is that in a declining market, the total return for the scammer may be disappointingly small. So to milk more from unsuspecting buyers some factories will go for an even bigger score. They go to their buyers and offer to sell their product at a substantial discount. But the price for this discount is a substantial increase in the order amount and an increase in the deposit from 30% to 50%. The Chinese side says: “It is a great deal for you. Make a full year of orders all at once and you will save big money.” Using this scam, the Chinese factory collects a much larger deposit amount and the owners shut down the factory and disappear.

In China Tariffs and What to do Now, Part 1 we focused on how Chinese factories were offering to illegally transship their products to Malaysia or Thailand or Vietnam or Bangladesh or the Philippines (mostly), thus avoiding U.S. tariffs:

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.

I bring this up because many of the same factories that are making this transship offer are at the same time offering to discount their prices in return for a large increase in the deposit. This sort of “double” offer to illegally avoid tariffs and raise the down payment amount is a terrific indicator of a brewing scam.

Model Scam Number Two: Chinese factory sells a standard product: usually something like a chemical or a basic raw material or a food product. As with scam number one, it pumps up its orders by offering a substantial discount — sometimes even too good to be true. In exchange for the discount, the factory requires full payment before shipment. Then the factory ships a non-conforming product, collects the payment and disappears.

The below are some examples brought to the attention of our China lawyers by foreign companies that were scammed:

  1. Container of custom cut food product: 25 containers, neatly packed. The first layer of these cartons contain conforming product. The rest of the container is filled with bricks.
  2. Barrels of a granulated chemical (say citric acid). The top two inches in each barrel is conforming product and the rest is filled with sand. Or barrels are for a liquid chemical (say sulphuric acid). The barrels are filled with salt water.
  3. Containers filled with frozen food product, which when thawed, reveal that the food is rotten. In my own experience, this happened with 8 containers of frozen salmon. The decay was so bad that the containers were declared a hazardous waste site and the buyer was required to pay the substantial cost of a hazardous waste clean up.

Model Scam Number Three. The owners of the Chinese factory contact a foreign customer (oftentimes a regular buyer who gets all or most of its product(s) from the dying Chinese factory) and offer to sell their business at a unrealistically low price. In exchange for this low price, the deal must close very fast. This fast close means no time for due diligence and no involvement of experienced and trustworthy China lawyers or consultants.

The foreign buyer pays the purchase price by wire transfer to the Chinese factory. Then the buyer travels to China to inspect its factory and here is what they find:

— The factory building was rented, not owned. The building is stripped. Not only has all the machinery been removed, but even the window glass and plumbing fixtures are gone.

— The bank account has been emptied by the former owners and they have disappeared.

— The landlord shows up and demands a full year’s rent on the factory that has not been paid. 200 hundred workers show up and demand 6 months back salary. The local government shows up and demands one year in back taxes. To make it even “better” the local government colludes with the workers to take the passports of the foreign owners, lock them up in a local hotel, and then announce that they will not be able to leave town until all back payments are made.

The above sort of scams are committed in China all the time. However, their frequency and severity increases whenever there will be a wave of factory closures and bankruptcies. This is what is predicted for the next couple of years for China, so particular care is now required. For some of the things you need to be doing now to reduce your chances of problems stemming from this wave, check out last week’s post, China’s Economic Slowdown and YOUR Business: The Times they are a Changin’.

And be careful out there.

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.

What with all the US-China tensions and trade tariffs, the most common questions our China lawyers are getting these days from clients are whether they should keep having their products made in China and “what should we do about the tariffs?” We will deal with this second question first by simply referring to the following posts we recently wrote on this subject:

As for the second question, we’ll start out by giving the lawyer’s favorite answer: it depends.

For our clients that make clothing or furniture or basic beauty products or basic kitchenware or rubber duckies or the like, we can say that in the last five years well over fifty percent already moved elsewhere, to places like Vietnam, Pakistan, India, Malaysia, Thailand, The Philippines Cambodia, Turkey and even Laos. In the last couple weeks our international lawyers have been checking in with these clients and flat out asking how they are liking their new countries and the word coming back is that they are not without problems but they prefer them to China and they are — for the most part saving money by doing their manufacturing in these places. But what if you are making electronics or auto parts or IoT devices or medical devices or pharmaceuticals or skincare or vitamins or the like? Incredibly few of these companies have moved out of China in the last few years and though many of them are now looking to do so, it does not seem that will or even can occur in the short term as there are very few factories outside China that make these things on a contract basis. We have though had discussions with many companies about setting up their own factories in these countries and the big issue for them — no surprise — is whether their moving will so much cut them off from the components they need to make these products as to cancel out any potential savings. Some of these companies in these industries are looking at Eastern Europe, Spain, Portugal, South Korea, Taiwan and the United States.

Overall though, it seems as though most companies that have moved some or all of their production outside China — usually with a fair amount of trepidation — are surprised at how easy it ended up being and how quickly they have adapted to the change. There have been some though who once outside China found their costs went way up, usually due to supply chain difficulties, and moved back.

That is where the “it depends” part becomes so relevant. Things like doors and door handles and windows seem almost to be the perfect middle ground as some have moved out of China already (mostly for Vietnam and Taiwan) and some are looking at moving out and yet some who moved out have returned and some who looked at moving out have — at least for now — decided to stay.

Interestingly enough, we are hearing increasing talk of foreign companies looking to buy their Chinese factories either to try to reduce costs or because the owner wants to retire and there is fear that the factory will go downhill after that. In doing their cost-benefit analysis nearly all of these companies are accounting for the tariffs as a permanent condition and we think that wise.

On the legal side, moving is relatively easy in that a good manufacturing contract is a good manufacturing contract and it is relatively easy for us to take an existing NNN Agreement or Product Development Agreement or Manufacturing Agreement or Mold Ownership Agreement and modify them to work for another country. It is though very important (with most of the countries listed above) that you secure a trademark for your company name, your brand, your product name and your logo in the new country to which you are moving and it virtually always makes sense to do that as soon as possible.

The above is why our final answer is “it depends.” We will over the next few weeks and months be writing often on what is involved in moving your production from China.

What are you seeing out there?

Asia Manufacturing Lawyers

With the recent onslaught of tariffs, our manufacturing lawyers are increasingly drafting manufacturing contracts for Asian countries beyond China. In the last few weeks alone, we’ve drafted manufacturing contracts for Vietnam, Malaysia, Indonesia, Taiwan, and India.

This recent increase in manufacturing contracts for countries beyond China has only reinforced how the core legal and business issues tied up with such contracts spans the globe. With so many companies (and clients!) looking to move some or all of their manufacturing to countries other than China, we will over the next few months be writing often about the basic concepts underlying good manufacturing contracts, no matter the country.

One of the issues our manufacturing lawyers perpetually face is pricing. How much will the factory charge for the widget and, more importantly, how much will the factory charge for the widgets a month and a year from now. Oh, and what about currency fluctuations?

Many of our clients (especially those recently stung by trade tariffs) are seeking to lock in pricing. This is a tough one. If you are maybe going to buy 1000 widgets at $34 from time to time with no minimum requirements, no legitimate factory anywhere will  lock in its prices for any extended period, if at all. They simply have no incentive to take a risk for an occasional buyer. On the other hand, if you contractually commit to buy five million such widgets, the factory will be a lot more willing to give you a price lock.

The same holds true for currency fluctuations/risk — which really just translates to price in the end. If you are an occasional buyer of 1000 widgets, you likely will not find a factory that will sell you its widgets for $34 for the next five years, no matter how much the Dong/Rupee/Ringgit/Bhat/Rupiah/Riel/RMB changes against the dollar. If you are buying five million widgets, sharing in currency risks very well might be doable.

Yet many foreign companies believe it possible to get a price lock when it really isn’t. Even worse, many foreign companies believe they have a price lock when they really don’t. Most factories throughout Asia are well-versed in how to convince their Western buyers that there is a price lock when there really isn’t. These factories lure buyers with a fake price lock and then when that price lock really matters, they easily and legally back out.

How do these factories accomplish this feat? Simply by refusing to accept a purchase they are under no obligation to accept. The below email from one of my firm’s lawyers regarding negotiations with a Vietnam factory nicely illustrates this sort of legerdemain:

The discussion on price adjustment is meaningless. If the Vietnamese factory is not required to accept all purchase orders with the locked price, it can simply change its price by refusing to accept your PO. It is standard practice in Vietnam (and pretty much everywhere else in Asia and around the world) for the Vietnamese factory to agree to a low price and in return get certain minimum order commitments from you the foreign buyer. Then when its costs rise (or less common, its currency rises) the Vietnamese factory will refuse to accept your purchase orders until you agree to pay a higher price. A price lock is only meaningful if the factory is required to accept your purchase orders with the locked price. In this case, your factory has rejected that approach, which means you will have no price protection. Your factory fully understands this and this is why they revised the contract as it did.

You must now decide whether you want to move forward with this factory without price protection or see if you can get price protection elsewhere. Or you might even want to see whether your agreeing to commit to buying more from this factory will get you a real price lock or not.

Please stay tuned for our next post in this series.

 

China attorney

In 2012, I wrote an article for the Wall Street Journal, entitled, China’s Slowdown and American Business. There was a slowdown happening in China at that time and the China lawyers at my law firm were “feeling it” from the emails and phone calls we were getting from foreign companies doing business in or with China. My WSJ article sought to address the issues our lawyers were seeing back then. Since that article, China has gone through intermittent slowdowns and during each of those we see pretty much the same same issues each time. Because China is again going through an economic slowdown — due in large part to a trade war that is only going to get worse– I thought now would be a good time to reprise that article and write again about how to handle a China economic slowdown. For more on China’s economic slowdown, see this CNN article from today, The trade war is deepening the gloom at Chinese factories.

China lawyers
China’s Economy is Slumping

The Wall Street Journal chose the following subheading for my 2012: “Hardly a week goes by without complaints about payment problems or bankrupt debtors.” If I were to choose a new subheading for this post today, it would be “Hardly a day goes by without complaints about getting  bad product and hardly a week goes by without someone asking about what will be required for them to shut down their China WFOE.”

The following are the key points from my Wall Street Journal that apply with at least equal force today:

Regulation. The best assumption to make is that the Chinese government will respond to the slowdown by attempting to minimize citizen discontent so as to keep its hold on power.

Sourcing Problems. The slowdown is changing Chinese company interactions with foreign companies. Chinese exporters, particularly those that compete with companies from lower-wage countries like Vietnam and Bangladesh, are suffering—in particular in low-tech, low-wage industries such as textiles, clothing, shoes and low-end electronics and toys. Foreign companies that do business with Chinese companies in these industries must be on their guard. Hardly a week goes by without one of the China lawyers at my firm getting a call from a Western company experiencing problems. Sometimes the Western company has paid for a product and the company it paid no longer exists. Sometimes the company still exists but it needs “more money” from the Western company to buy raw materials for the product it already promised to produce.

Foreign managers need to understand what is happening in their own industries within China. This might mean visiting your Chinese factory, warehouse or office to look for warning signs of a company in distress. Or it might mean taking out insurance to cover your China business or transaction. A number of Chinese manufacturers are owned by Taiwanese, Singaporean or Hong Kong companies, and sometimes it is possible to secure guarantees from the foreign parent.

The key is to be proactive: If you find yourself in a bad situation with a Chinese company going under, there usually is no remedy after the fact. Bankruptcy in China more often than not consists of a company shutting down in the middle of the night and its owner fleeing to another town.

The key to weathering China’s slowdown will be for foreign companies to go back to basics …. focus on scrupulous regulatory compliance; and renew focus on due diligence at a company-to-company level. Above all, no Western company doing business in China should blithely assume that a slowdown won’t affect it.

Updating the article, the biggest change from 2012 to today is the massive increase in Chinese companies willing to risk their relationships with the very same foreign companies with whom they currently do business. We wrote about this previously in Your China Factory as your Toughest Competitor. But it is now not just factories; our China lawyers are seeing this in all industry sectors, especially technology. Our China lawyers have become fond of pointing out that “since you will essentially be educating your Chinese party in how to compete with you, you need contracts that will at least limit what they can do when they do so.”

Why are China companies now so willing to risk losing out on business with existing customers to go into business competing with them? When times are bad, greater risk becomes necessary to pay employee wages and to stay alive.

China’s manufacturing sector has taken a hit from migration of international business to lower wage and cheaper countries across South East Asia. Since President Trump’s first round of tariffs, our international manufacturing lawyers have seen a near 50% increase in work involving Vietnam (mostly), Indonesia, India and Malaysia. And with one or more of these countries coming up in so many of our conversations with clients, we are quite certain this migration to SE Asia will only increase, no matter what happens on the trade war front. With manufacturing moving elsewhere, many Chinese companies rightly believe they need to do something different and heir seeking to compete with their own customers is that something different.

We are getting at least two calls/emails every week from companies seeking help in trying to remedy/stop their Chinese suppliers from using their molds or their information or their customers to compete with them. We have gotten more calls in the last three months 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 and willing 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. In nearly all instances there is little we can do. Though it might be possible to sue these Chinese companies, without rock-solid China-specific contracts in place, such lawsuits seldom make economic sense. See China Contracts: Make Them Enforceable Or Don’t Bother.

China tariff lawyers

In talking with one of our international trade lawyers yesterday I learned that September 6th is the next key date regarding the $200 billion round of tariffs against China imports. This is the due date if you want to submit comments on your particular category of products in an effort to get that category removed from the tariff list.

It is already too late to submit comments regarding the first two tariff lists — the first $34 billion list and the second $16 billion list. However, if your product is on either of these lists, you still can make a product exclusion request. The product exclusion request process for the Second list will be similar to the process set up for the first list, but no deadlines have been established yet.

Decisions on exclusion requests typically require/hinge on the following:

  • Identify the product you want excluded.
The U.S. list of targeted products is identified by the Harmonized Tariff Schedule (HTS) number used to declare the product when imported into the United States. A company must identify the commercial name of the product, the HTS number for the product, and any other industry designation of the product under a recognized standard or certification (For example, ASTM or DIN).
  • Describe the product based on physical characteristics.
Physical characteristics can include, but are not limited to, chemical composition, metallurgical properties, and dimensions. This description distinguishes your products from other products subject to tariffs. A significant concern when considering exclusion requests is whether granting a specific exclusion request will create a loophole which other products will also be able to exploit.
  • The basis for requesting an exclusion.
Reasons for the exclusion request include, but are not limited to, the following: The product is unavailable from a domestic U.S. supplier; thus, imports are needed to fill a demand no U.S. supplier can meet. There are certain requirements only the 
import supplier can satisfy. The company has been put on allocation by domestic suppliers. There are no alternative suppliers in a country outside China.
  • The names and locations of any producers of the product in the United States and in foreign countries.
  • Total U.S. consumption of the product by quantity and value for each year for the past three to five years (2013 – 2017)
  • Projected annual consumption for the next few years (2018- 2020), with an explanation of the basis for the projection. 
Total U.S. production of the product (or possible substitutes) for each of the past three to five years.
  • Discussion of why the U.S. products (or possible substitutes) cannot be used in place of the imported products.
  • A viable narrative detailing why your company deserves the exclusion it is requesting. This typically includes the history of your company (e.g. fifth generation family-owned), the products produced by your company, the strategic significance of your company’s products, the number of workers in your company, and your company’s annual sales.

Successful comments result in the removal of tariff line items from the tariff list, contrasted with successful exclusion challenges which result in the removal of specific products from the tariff line item. In other words, the requirements for the exclusion process are much more product specific. This means if you have nine different types of widgets, you will need to make nine different product exclusion requests. 
The reasons given by the USTR for invoking the China tariffs center around Chinese practices of stealing or extorting intellectual property from U.S. companies. There have already been many opposing comments and exclusion requests submitted for the first two waves of proposed China tariffs noting that the tariffs have no relation to the premise of protecting U.S. companies. Many have also objected to the catastrophic effect these tariffs will have on certain American companies while likely having very little effect on how China respects U.S. intellectual property.

It is important to note that out of the first round of $50 billion in tariffs, comments led to $16 billion (32 percent) being removed. If your product or products are on any of the lists, it almost certainly behooves you to try to get them off. Your biggest risk of doing nothing is having to go up against one or more of your competitors that did do something and succeeded and whose costs are now a lot less than yours.

But you do need to reach out to an international trade lawyer FAST.

 

China tariff lawyer

This is part two in what will no doubt be a continuing and long running series on what American companies can and should be doing in light of the ongoing trade war between the United States and China. In part 1, I discussed how our  China lawyers are getting a slew of phone calls and emails from companies looking at massive tariffs being imposed on their products imported into the United States and wondering what they should do.

That first post focused on what companies facing tariff problems 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.

But what should you do? The below is the sort of plan our international trade lawyers (working in tandem with our China lawyers) are mapping out for companies needing our help:

The first and most obvious thing to do is to figure out how your products will be impacted. Has the United States imposed tariffs on your products? Is it planning to do so? Just this first step is more complicated than many realize both because it is not always clear whether a specific product comes within the classification of a product against which tariffs have been imposed and because the media has been less than clear in distinguishing between existing and upcoming tariffs.

If one of your products is on a U.S. tariff list, your next step is to figure out what you can do about that. Surprisingly enough, you do have options. 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. And later waves of U.S. tariffs will have later dates by which comments must be made. Out of the first round of $50 billion in tariffs, comments led to the removal of $16 billion (32 percent), which shows there is real value to challenging these tariffs.

But even if your product is not exempted due to challenges, you can make what is called an exclusion request. These too have their deadline dates and these exclusion requests typically include the following:

  • Identify the product you want excluded. The U.S. list of targeted products is identified by the Harmonized Tariff Schedule (HTS) number that is used to declare the product when imported into the United States. A company needs to identify the commercial name of the product, the HTS number for the product, and any other industry designation of the product under a recognized standard or certification (for example: ASTM, DIN).
  • A description of the product based on physical characteristics (for example: chemical composition, metallurgical properties, dimensions) so your product can be distinguished from other products that would still be covered by the tariffs. A significant concern in considering exclusion requests is whether granting a specific exclusion request will create a loophole many other products can also use.
  • The basis for requesting an exclusion. Is the product unavailable from a domestic U.S. supplier and thus imports are needed to fill a demand no U.S. supplier can fill. Are there certain qualification requirements only the import supplier can satisfy? Have you been put on allocation by domestic suppliers? Are there alternative suppliers in any country other than China?
  • The names and locations of any producers of the product in the United States and in foreign countries.
  • Total U.S. consumption of the product by quantity and value for each year for the past three to five years (2013 – 2017) and projected annual consumption for the next few years (2018- 2020), with an explanation of the basis for the projection.
  • Total U.S. production of the product (or possible substitutes) for each of the past three to five years.
  • Discussion of why the U.S. products (or substitute products) cannot be used in place of the imported products.
  • A good story why your company deserves the exclusion it is requesting. This typically includes the history of your company (e.g., fifth generation family-owned), the products produced by your company, the strategic significance of your company’s products, the number of workers in your company, and your company’s annual sales.

The difference between the comment process and the exclusion process is that successful comments lead to the removal of tariff line items from the list whereas successful exclusion challenges remove specific products from the tariff item. In other words, the requirements for the exclusion process are much more product specific; if you have six different types of widgets, you will have to make six different product exclusion requests.

The first deadline for a product exclusion list is October 9th for the first $34 billion list.  USTR has not yet set up Product Exclusion requests for the $16 billion, not to mention the $200 billion list.  So we are still waiting on that.

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.

A U.S. exclusion process will likely proceed fairly slowly because there are so many exclusion requests already in the pipeline for the steel and aluminum tariffs, though a successful exclusion request likely will result in a refund of any tariffs paid. Waiting for a tariff refund is not the best thing in the world, but requesting such a refund will be the best path for many. Our trade lawyers are representing companies in more than a dozen industries that are seeking to have their products excluded from tariffs.

In part 3, we will discuss what actually makes a product “Made in China” for purposes of United States tariffs and what you can legally do to take your products outside that classification.

 

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 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 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 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?