international trade lawyersDespite the federal government shutdown, there have been a couple of recent developments regarding the Section 301 tariffs imposed by the Office of the U.S. Trade Representative (“USTR”) on a broad range of products imported from China.

First, on December 28, 2018, USTR published its determination for the first batch of exclusion requests granted for the 25% tariffs imposed on $34 billion worth of Chinese imports (List 1). USTR granted exclusions for 984 separate requests. Based on the USTR’s index of product exclusion requests, USTR also rejected around 1,000 exclusion requests. Thus far, USTR has made decisions on only about 20% of the 10,000 exclusion requests for the first tranche of China products, with the remaining exclusion requests still being considered.

Importers will be eligible to apply for refunds of the 25% tariffs paid on the List 1 products entered after their July 6, 2018 effective date. The product exclusions will remain in effect for one year, expiring on December 28, 2019.

USTR indicated that the product exclusions will be applied on a product basis, meaning all imports of the product will be excluded regardless of whether the importer filed an exclusion request. This is different from the steel/aluminum tariff exclusion request process which limited the exclusions only to the specific products identified by the specific requesting party.

Second, on January 11, 2019, USTR replied to eleven Democratic senators who had asked why an exclusion process had not yet been established for the $200 billion of Chinese products (List 3) subject to a 10 percent tariff similar to the exclusion request process already in place for the prior list of Chinese products (List 1 – $34 billion; List 2 – $16 billion). USTR stated that an exclusion process for the List 3 products would not be established unless negotiations fail to resolve the US-China trade dispute by President Trump’s March 1, 2019 deadline. If no US-China resolution is achieved,  tariffs on List 3 will increase from 10 to 25 percent on March 2, 2019.

These developments show that although some progress is being made on the Section 301 tariff exclusion requests, that process is going to be slow.  USTR has barely made a dent in the thousands of exclusion requests for the first two lists of Chinese products and it has deferred starting the exclusion request process for the much bigger $200 billion list of products. U.S. importers in the meantime will be required to continue paying the 10 or 25 percent tariffs while waiting for USTR to slog through the outstanding exclusion requests or for the U.S. and China to find a way to end the trade dispute. The companies for which my firm’s international trade lawyers filed exclusion requests are incredibly frustrated at not yet hearing back.

If Presidents Trump and Xi reach some agreement by March 1, 2019 the tariffs will likely be immediately lifted, but if they do not reach such an agreement by March 2, the U.S. will then increase tariffs on the $200 billion of List 3 Chinese products from 10 percent to 25 percent and very likely impose 25 percent tariffs on all remaining Chinese imports (about another $260 billion).

More to come. A lot more.

international litigation lawyersEuler Hermes, the German credit insurance company, recently released its bankruptcy filing projections for 2019 here. The Report states that bankruptcies worldwide increased by 10% in 2018 and it projects an additional 6% increase for 2019.

What surprised me is that the increase in bankruptcies worldwide stems almost solely from an increase in formal bankruptcy proceedings in China. The 10% increase worldwide for 2018 was due almost entirely to a 60% increase in China bankruptcies. In 2019, the projection is for a worldwide increase of 6%, with China once again by far the highest in the world with a projected 20% increase.

This compares unfavorably with the relative stability of China’s East Asian neighbors: Japan, Korea, Taiwan and Hong Kong, which are all projected to have a 2% or less growth in bankruptcies in 2019. China also compares unfavorably with the 0% growth in bankruptcies projected for the United States and Germany, China’s two primary European and North American economic competitors.

What is fueling China’s tremendous increase in formal bankruptcies? The Report cites two factors:

“The [ projected 20% increase] will result on one hand from the on-going softening and adjustments of the Chinese economy, notably in regards to credit growth, Belt and Road Initiative and international trade issues, and on the other hand from the increasing inclination to use insolvency procedures, in particular by the authorities, in order to clean the ‘zombie’ state-owned enterprises (exceeding 20,000 cases according to some studies).”

Weakness in China’s economy in generally well known and undisputed. See The Top Ten Issues for China’s Economy and China’s Economic Slowdown and YOUR Business. I am going to focus here on the issue of “zombie” state-owned enterprises. The zombie SOEs are smaller enterprises owned by provincial and lower level Chinese governments that have been money losers for decades. The central government has been pushing to shut down these SOEs for many years, but the local governments have resisted, primarily to prevent job losses and the resulting social unrest.

The Euler Hermes Report suggests the Chinese central government will increase pressure against these zombie SOES in 2019 by taking even more aggressive steps to forestall local government insistence that non-performing SOEs be kept on artificial life support. We should therefore expect a wave of SOE closings in 2019. Some will make use of formal bankruptcy proceedings. If past practice is an indicator, even more will simply disappear. In both 2018 and already in 2019, the international litigators at my law firm have handled a massive increase in matters where a foreign company has paid its Chinese manufacturer for product only to get nothing (or almost nothing) in return and then to learn that the manufacturer no longer exists. See China Business Scam Week, Part 2: Bricks for Products. You must be on your guard for this sort of thing, starting NOW. See China’s Economic Slowdown and YOUR Business.

This slew of China bankruptcies and disappearing companies is an important issue for foreign companies doing business in China or with China. Many foreign business people believe the risk of a sudden closure of a supplier is limited to privately owned Chinese companies. Many foreign companies falsely believe the Chinese government will protect SOEs from any form of economic downturn and, therefore, SOEs are “safer” than their private competitors.

But as the Euler Hermes Report shows, this belief is not based on the facts. Chinese government policy is to protect a group of about 200 “state champion” SOEs. Virtually all other SOEs (without regard to which type of government is the owner) do not benefit from Beijing’s protection and these other SOEs are fair game for closure. China’s central government periodically imposes a program designed to clean up the balance sheet and close non-performing (zombie) SOEs. This type of clean up program is projected for 2019.

What does this mean for foreign buyers? First, it means that long term suppliers of critical products and materials will suddenly disappear without notice, leading to predictable chaos in the supply chain. Second, it means the affected Chinese SOE then has a very strong incentive to make a final fraudulent sale in order to extract a profit from one or more foreign buyers. This profit is then pocketed by the managers who then disappear. This type of scheme has been employed almost as standard procedure in the past and there is no reason not to expect this type of fraud will be used during the 2019 SOE clean up campaign. We wrote about the need to watch out for this sort of scam in China Business Scam Week, Part 2: Bricks for Products:

These things happen with companies that want to make a few final sales before they file for bankruptcy or just shut down and disappear. Just imagine the profits to be made from three $350,000 sales for which no product is ever provided. So just imagine the incentive for the owners of the Chinese manufacturing company to sell and not supply to foreign companies right before (or sometimes even right after) they shut their doors for good.

The China lawyers in my law firm call this the bricks for product scam because the first time we ever saw it was more than a decade ago when a U.S.-Norwegian fish company bought about a million dollars in fish from a Chinese company and every container consisted of a thin layer of fish wrapped around a core of bricks. The local SEOE company that sent the fish for bricks had shut down and its managers had fled town and were nowhere to be found. Or at least that is what the local government told us. In that case (as in most that we see), there were plenty of warning signs, all of which were ignored.

The standard technique is to offer a discount for a larger than usual sale amount and then deliver nothing or almost nothing. Sometimes nothing at all is shipped. In other cases, a fraudulent shipment is made: a container full of bricks, barrels full of water or sand, or a refrigerated container full of rotten fish or fruit. By the time the foreign company discovers the fraud, the Chinese company (often a local SOE) has already been liquidated and its owners/managers have disappeared. Much of the time, little can be done.

However, if the Chinese company formally declares bankruptcy (which does happen) and if it has some assets left (which also does happen) and if you have a China-centric manufacturing contract (see On SMEs Trusting China Manufacturers. Don’t. Just Don’t.) you at least have a chance at getting some or all of your money back. Even better, of course, is to delay payment until after you have confirmed delivery of conforming product.

Bottom Line: The message of this post is that the danger of paying and getting nothing from your Chinese supplier comes from BOTH private companies and from SOEs. Based on my own experience, I see the SOEs as a greater danger. When you get an offer from a Chinese supplier that seems “too good to be true,” it is. Extreme care is required.

China Manufacturing ContractsIn yesterday’s post, On SMEs Trusting China Manufacturers. Don’t. Just Don’t., we wrote about product outsourcing mistakes often made by small companies (SMEs). The same day we wrote that post, The Quality Inspection Blog did a post, 9 Things Only a Large Company Can Obtain in China/Vietnam, comparing what large companies are able to achieve when outsourcing their product manufacturing that small companies cannot.Before I discuss Quality Inspection Blog’s post (by analyzing the nine things it cites) I want to note how true it is. Small companies sometimes read how they should do X with their product manufacturing and then insist on doing X even though virtually no product manufacturer in China or Vietnam or Thailand or Mexico or Cambodia or the Philipines or wherever would ever go along with X unless HUGE product quantities are ordered. Put simply, Walmart can require certain things of its product suppliers around the world that your company cannot.

The first thing that springs to mind is product exclusivity. Our manufacturing lawyers usually ask our clients that are looking to have a product made overseas whether they are concerned with their foreign manufacturer making the same product for others. When we ask the question using the word “same,” and our client responds “yes,” we then ask what for them constitutes the same product. Sometimes they will respond with something broad like “I don’t want them making IoT devices for anyone else” When I get this sort of response, my thought is that this is never go to happen unless our client is prepared to purchase billions of dollars a year in IoT devices from this one manufacturer. I say this because most contract manufacturers that make products for small companies make their products for from 3 to 300 foreign companies. No manufacturer that makes IoT devices for 100 companies will stop making IoT products for all 100 companies just to secure your $800,000 in yearly business. The economics of that are just not there.

In this sort of situation, our manufacturing lawyers will usually provide the following sort of explanation as to why what our client seeks is both impossible and unnecessary:

Wait a second. This company you wish to use to make your IoT product. It makes all sorts of IoT products for all sorts of other companies around the world, right? And your IoT product is a health device you plan to sell to health clubs in Canada and the United States, correct? So why do you even care that this company makes and sells IoT devices for olive growers in Spain, Israel and Greece? You don’t care about that do you? I am asking these questions because there is no way this manufacturer is going to stop making IoT devices for olive growers in Spain, Israel, and Greece just to get your start-up order for 10,000 health club IoT devices and I am not aware of any reason why this should matter to you. So how about we just try to get this manufacturer to agree (with China-enforceable NNN provisions) not to make or sell health club IoT devices?

Quality Inspection Blog starts its post by discussing how there is much good advice on “Linkedin and elsewhere, aimed at importers sourcing products from China, Vietnam, or other low-cost Asian countries” but much of this advice is NOT applicable to companies buying under 20 million USD a year — and, sometimes, not under 1 billion USD a year.” It then lists out the following nine things large importers can get from their suppliers but small companies usually cannot. Note that my summary below of the Quality Inspection Blog is in regular font and my own comments/opinions are in italics.

1. Negotiate with large contract manufacturers in many countries. Apple has been looking at producing iPhones in Vietnam and/or in India. Apple knows “large contract manufacturers (e.g. Foxconn) are willing to set up a plant wherever Apple wants.” But if you are a company looking to buy 5,000 mobile phones in Vietnam or India, you very well may not be able to find anyone to make them for you in such a small quantity. This is so true. Our law firm has been working a lot lately with clients looking to source electronic products from Vietnam and Thailand and the Philipines and unless they are willing to buy in fairly large quantities, they are not having much luck in finding suppliers. But much depends on the product and the country. For instance, many of our toy and houseware product clients were able to relatively easily shift their contract manufacturing manufacturing to Vietnam and Thailand. 

2. Reserve production capacity for the mid- or even the long-term. Quality Inspection Blog mentions having heard how VF Corporation was able to reserve the capacity of several buildings in Chittagong, Bangladesh. Large companies with mature planning and distribution systems have a good idea about their needs five years into the future and they can often find contract manufacturing companies that will reserve them the capacity to realize those plans. So true, but for a small company this is just virtually never going to happen. 

3. Negotiate directly with large sub-suppliers. Li & Fung can reserve greige fabric and dyeing capacity before it knows for certain the colors its massive list of clients will choose. Li & Fung can do this because it has massive buying power and because it is able to talk directly with large sub-suppliers. In many cases, contract manufacturers will refuse even to reveal from where it gets its materials and components to its small company buyers.

4. Open-book visibility about the manufacturing facility. Large buyers are often able to get deep-dive costing information from their contract manufacturers. Things like the “what their supplier pays for rent, per employee, for each line on the bill of materials, and so on. For large buyers such as General Motors or Airbus, this is a given. Any part supplier not willing to share this level of detail is discarded.” Small companies generally should not even bother asking for such information. 

5. Force the factory to use your own ERP system. Many tier-one auto suppliers have to use an SAP implementation that perfectly integrates with the SAP implementation used by their buyers. “So, if 50% of a plant’s activity is for GM, 40% is for Chrysler, and the rest is for smaller customers, the plant will need to use 3 different ERP instances.” Small companies often work with suppliers that don’t use ERP at all.

6. ‘Open account’ payment terms. This is much more common for large companies. I am always impressed by small companies that are able to pay 50% or less upfront. For more on manufacturing payment terms, check out China Manufacturing Payment Terms.

7. Product warranty & liability from the supplier. Large companies can get their manufacturer to sign legally-enforceable contracts that make it liable for product warranty and liability obligations and that require the manufacturer to carry liability insurance. “This is pretty much unheard of for an importer buying ‘only’ 500,000 USD a year from a given factory.” I disagree with this statement as we are nearly always able to get overseas factories to sign for good warranties. However, this whole area of warranties and liability insurance is a minefield. How valuable is a warranty if you are working with a manufacturer that has only $100,000 a year in profits? See China Manufacturing WarrantiesHow valuable is it to get your manufacturer to buy a crappy insurance policy written in Vietnamese? Also, if you require your manufacturer to spend 30 cents per widget for insurance, it likely will just flip around and charge you 30 cents more per widget to cover this cost. Might you not not be better off just buying your own insurance in your own country for 30 cents per widget? See The China Price and Product Liability Insurance: Never the Twain Shall Meet

8. Shaping the supply chain PHYSICALLY. “You set up a mammoth plant and you don’t want your high-value component suppliers to be more than 1 hour away from you, for just-in-time inventory replenishment? They can be requested to set up a new manufacturing facility next to you.” Small company? No way.

9. Have their own teams on site all the time. “When you develop new products, can you afford to have your own engineers at the main factory, and going around component factories as well? Probably not with the same intensity as, say Apple (who dispatch not only engineers but also supply chain security staff and so on and so forth). In the end, that makes a very large difference in quality & time-to-market performance.” True, but there are a number of very good quality inspection companies, including the company — Sofeast —behind the Quality Inspection Blog. Not quite the same thing as having ten of your own people live in the factory, but a thousand times better than no monitoring at all. 

I am going to add a tenth item: price stability. Large companies are often able to get their suppliers to commit to long-term pricing, whereas this is just not possible for most small companies.

So what can small companies that use overseas contract manufacturers do to protect themselves? Go with the basics, as described (at least in part) in our post yesterday.

What are you seeing out there?

China manufacturing lawyer
China manufacturing: Trust but verify. Better yet, just verify.

One of the things I love about my law firm’s China practice is its diversity. We represent all sizes of businesses, from start-ups that never really start to Fortune 50 companies that have been in China for more than twenty years. This sort of diversity more than holds true on the manufacturing side of our legal work as well.

I am bringing all of this up because with the massive changes we have been seeing in outsourced manufacturing this year, the operational differences between our biggest clients and our smallest clients have been coming to the fore. This is happening because having a product made in China is far more complicated today than it was five years ago, for the following reasons:

  1. The U.S. tariffs. This is having a deep and a wide impact. Any company that has products shipped into the United States from China has already been directly impacted by this or likely will be within the next few months. Any company that has products made in China is — at least to a certain extent — already impacted by this.
  2. Chinese manufacturing companies are very concerned about the US tariffs and you should not believe anyone who tells you otherwise. Our China manufacturing lawyers know this because we have seen a massive increase in Chinese companies walking off (early) with the IP they are shown by their foreign buyers and potential buyers.
  3. Chinese manufacturing companies are very concerned about the US tariffs and you should not believe anyone who tells you otherwise. Our China manufacturing lawyers know this because we have seen a massive increase in Chinese companies taking foreign company money and then disappearing. We also keep hearing rumors of Chinese factories that will not be re-opening after the Chinese New Year. If this rumor holds for a Chinese factory you are using, you should do whatever you can not to allow that factory to tie up your money in the meantime.
  4. Chinese manufacturing companies are very concerned about foreign companies leaving them and switching their manufacturing to Vietnam or to Thailand or to Cambodia or to Mexico or to the Philippines or to wherever. Our China manufacturing lawyers know this because we see this switching happening with our own clients and because our own clients are telling us that their own factories are saying this. Our law firm drafted more contracts for Vietnam, Thailand, Mexico and the Philippines in the last six months than probably the previous three years.

So what does this all mean for your China manufacturing and why did I start this post by talking about how the difference between big and small foreign companies is coming to the fore.

Well, let me start out by describing how most big companies handle their outsourced China manufacturing. The typical large company will send one or two or three of its own people to China to research and investigate and examine and test potential Chinese factories. If they don’t send 1-3 of its own people, they will hire a high end and highly regarded China sourcing company (expert in their particular products) to do this researching and investigating and examining and testing for them. Once the big company has found its potential Chinese factories, it might have them compete against each other to see who can make the best widget. Before doing anything with anyone in China, however, this big company most likely went off and secured China trademarks for its company name, its brand name, and its logos — at least whatever names and logos it will be putting on the products and packaging it will be having made in China. China Trademarks: Register Yours BEFORE You Do ANYTHING Else. This big company also required each of its potential China NNN AgreementChinese suppliers to sign an enforceable before it showed any supplier anything that might be deemed to be a trade secret.

Then once the big company determines the Chinese factory (or factory) it will be using to make its products, it makes that factory sign a comprehensive China manufacturing agreement. See China Manufacturing Contracts: OEM, CM, and ODM Arrangements, China Manufacturing Contracts, Part 2: ODM ArrangementsChina Manufacturing Contracts, Part 3: An Original Development Manufacturing Agreement that Works. This contract will almost certainly be in both Chinese and in English and, most importantly, it will be enforceable in China and contain well-thought out contract damages/liquidated damages provisions. See China Contracts: Make Them Enforceable Or Don’t Bother and China Manufacturing Agreements. Make Liquidated Damages Your Friend. This manufacturing agreement will also not be in just the English language and it will provide for various protections of the IP in their product and their mold. See China OEM Agreements. Why Ours Are In Chinese. Flat Out. and Protecting Your Product From China: The 101. In other words, the typical big company analyzes its various China risks and it registers its IP in China and drafts its contracts for China so as to greatly reduce those risks. These big companies do not subscribe to the myth that “Chinese contracts are not worth the paper they are printed on.” Note that the World Bank ranks China number 6 out of 190 countries on “enforcing contracts.” This

Unfortunately, most small companies do not act at all similarly and the risks of this are now sky-high. These risks are sky-high right now because so many Chinese companies now see themselves at great risk of going under. This fear is driving them to take short term actions that they were a lot less likely to take when times were good. This fear is driving Chinese factories to take foreign company IP and money way faster than in the past.

In China Trademark Theft. It’s Baaaaaack in a Big Way, we explained how we were seeing a massive increase in quick-fire trademark thefts:

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.

Similarly, in just the last 4-5 months, our law firm has seen a massive rise in situations where a foreign company (usually American or European or Australian) has paid its Chinese factory for its products yet never received anything, or received product of such bad quality as to indicate that the factory did not even try. We are also seeing a massive increase in small companies getting victimized by the China bank switch scam. See China Scam Week, Part 3: The Switched Bank Account Scam. But with this twist: half the time we believe the factory itself is somehow participating in this scam and it is doing so because it believes it will soon be out of business and so it’s grabbing money from wherever and however it can.

Why do all of these terrible things happen to small businesses that want nothing more than to have good product made in China? I think it is because they have let their guard down at the absolute worst time. These small companies have seen how good it can be to have products made in China and they are ignoring how bad it can be. What should these small companies be doing that they can actually afford to do? What is the baseline of what these SMEs should be doing to protect themselves from China? I say it’s the below and if you are not willing to do at least these things, you should not be having your product made in China (or in Vietnam or Thailand or the Philipines or Mexico for that matter either).

1. Go yourself and check out your potential China factories. If possible, bring along someone you trust who is fluent in Chinese.

2. Register your company name and your brand name as a China trademark before you reveal either to anyone in China.

3. Make your potential China factories sign a well-crafted China-centric NNN Agreement before you reveal ANY secret.

4. If it makes economic sense to do so, have a well-crafted China-centric agreement (or agreements) that protects your molds and tooling and that specifies exactly what it is that your factory will be making and exactly when it must deliver that. See How To Get Good Product From China; Specificity is THE Key To Your OEM Agreement.

5. Check in from time to time with your China factory, if only just by phone. Talk with the factory owner. Ask him or her “how things are going.” Oftentimes they reveal their fears.

6. Read China’s Economic Slowdown and YOUR Business: The Times they are a Changin’.

7.  Be careful out there. And towards that end, please note that the US State Department raised the risk level on going to China, with the following explanation:

Exercise increased caution in China due to arbitrary enforcement of local laws as well as special restrictions on dual U.S.-Chinese nationals.

Chinese authorities have asserted broad authority to prohibit U.S. citizens from leaving China by using ‘exit bans,’ sometimes keeping U.S. citizens in China for years. China uses exit bans coercively:

  • to compel U.S. citizens to participate in Chinese government investigations,
  • to lure individuals back to China from abroad, and
  • to aid Chinese authorities in resolving civil disputes in favor of Chinese parties.

In most cases, U.S. citizens only become aware of the exit ban when they attempt to depart China, and there is no method to find out how long the ban may continue. U.S. citizens under exit bans have been harassed and threatened.

U.S. citizens may be detained without access to U.S. consular services or information about their alleged crime. U.S. citizens may be subjected to prolonged interrogations and extended detention for reasons related to “state security.” Security personnel may detain and/or deport U.S. citizens for sending private electronic messages critical of the Chinese government.

What are you seeing out there? How do you protect your company and yourself from China?

 

 

How to avoid the china tariffsAs has been widely reported, the United States and China agreed to a temporary “cease fire” in the current round of tariff escalation. This happened this weekend at the G20 meeting in Argentina and the formal results of the meeting are not known. However the White House has issued a press release that outlines the basic terms of the deal that was cut in Buenos Aires.

On the tariff issue, there are two components to the G20 agreement:

First: The U.S. had threatened to raise tariffs on $200 billion in Chinese product from 10% to 25% effective January 1, 2019. In exchange for the United States not raising tariffs in January, China has agreed to purchase a “substantial, amount of agricultural, energy, industrial, and other product from the United States” so as to reduce the trade imbalance between the the U.S. and China. Note the following regarding this:

First,

  1. The list of products has not been determined.
  2. The purchasing dates have not been determined.
  3. This kind of agreement is standard. China obtains concessions in return for agreeing to purchase products but it never does purchase the products as promised. There is zero doubt the US negotiators are well aware of this predilection.
    The trade deficit is not the core basis of the United State’s Section 301 claim against China. So even if China makes these purchases, this does nothing to address the issues that support the imposition of the existing and proposed tariffs.

Second, the parties will enter into negotiations over a 90 period. These negotiations will be designed to resolve the issues that actually do form the basis of the U.S.’s Section 301 claim against China. As summarized by the White House, the US and China will discuss forced technology transfer, intellectual property protection, non-tariff barriers, cyber intrusions and cyber theft, services and agriculture. None of these issues can be resolved by China merely increasing its purchases of U.S. goods and services. The White House release then states in absolute terms:

If at the end of this [90 day] period of time, the parties are unable to reach an agreement, the 10% tariffs will be raised to 25%.

As someone who has been involved with these sorts of China IP issues for decades, I view the odds at near zero that China will make significant and meaningful changes in their system on the issues that will be discussed.  This means that if the White House is serious about its absolute deadline the chances of the tariff rate being increased come March are nearly 100%. However, tariffs are very unpopular in the U.S. business community, so it is not at all clear what Trump will actually do 90 days from now.

All of this means the new normal is still operative for China-United States business relations and U.S. companies that are doing business in China should us the next 90 days to make their plans on (a) how to begin or continue relations with their Chinese counterparts and (b) whether and how to move to other countries to mitigate the continuing China risk.

What will you do?

Doing business in Thailand

 

By: John DiDominic*

With all that has been happening with China lately on trade, Thailand is emerging as a highly attractive investment destination. Thailand has consistent and well-defined investment policies, increasing regional connections, and a government committed to improving its transportation infrastructure. It also (for the most part) has had long-term political and economic stability.

Thailand is Southeast Asia’s second largest economy with a well-established market system. In addition to being an attractive production base, its 70 million people make for a dynamic consumer market.

Thailand is well located between India and China and it shares maritime boundaries with Vietnam, Indonesia, and India. Thailand is the anchor economy for the neighboring developing countries of Laos, Myanmar and Cambodia and it is strategically located to serve markets in and beyond Southeast Asia.

The business climate in Thailand is welcoming to foreign investment and further deregulation and trade liberalization are taking place on many fronts, largely driven by Thailand’s participation in the Association of Southeast Nations (ASEAN) Economic Community (AEC). According to a recent World Bank study Thailand’s business climate has improved considerably since 2013 and it now ranks as the second most promising economy in East Asia. The World Bank rightly describes Thailand as “one of the great development success stories. Due to smart economic policies it has become an upper middle income economy and is making progress towards meeting the Sustainable Development Goals.” The World Bank Group’s 2017 Doing Business report “ranks Thailand in 26th place among 190 economies in the ease of doing business for small and medium enterprises around the world, up from 48th place when applying the same methodology to last year’s and this year’s data. The report also recognizes Thailand as one of top 10 economies that have improved most in the ease of doing business in the last year worldwide.” China came in at number 78.

Thailand is already a major destination for foreign direct investment and China’s trade problems have put that into hyperdrive. I moved to Thailand to live and work in 2007 and this is the best I’ve ever seen it.

Thailand 4.0

Thailand’s industrial sector is looking to move up the value chain and expand its capabilities to produce greater value-added products in a variety of modern industries.  These include the fields of Robotics, Medicine, Aviation, Advanced Manufacturing, Biotechnology, Nanotechnology, Advanced Material Technology, and Digital Technology. These efforts are known as Thailand 4.0, a master plan to move the country from one of an abundance of cheap unskilled labor to an innovation-based value economy. This strategy seeks to spur industries to progress up the technology ladder.  Thailand 4.0 mandates broad reforms that address economic stability, ease of doing business, human capital, equal economic opportunities, environmental sustainability, competitiveness, and effective government bureaucracies.

Incentives

In the current competitive global marketplace, simply possessing a favorable geographic location, efficient infrastructure, stable government and stable access to natural resources is often not enough to attract interest from multinational businesses searching for the optimal placement of their next factory. To stay ahead of regional rivals in competing for finite investment dollars, Thailand offers several financial and other incentives for companies keen to set up shop there. These incentives can vary by product and location but include the following:

·         Tax Incentives:

o   Exemption of up to 15 years on corporate income tax for certain industries

o   ASEAN’s second-lowest corporate tax rate (20%)

o   Double deductions for transportation, electricity and water supply costs

o   An additional 25% deduction for the cost of installing or constructing facilities

o   Exemptions on import duties for some essential materials and machinery

o   Tax deductions of up to 300% for qualified R&D expenditures

o   Tax deductions of 200% for qualified expenditures made in intellectual property acquisition and licensing fees for commercializing technology, technology training; donations to specific research and training institutions, and sourcing support

·         Non-Tax Incentives:

o   Special four-year visas for skilled workers and high-level executives

o   The right to lease state land for up to 99 years.

o   Permission to bring in foreign workers, own land, and take or remit foreign currency abroad.

o   Subsidies for energy conservation programs

·         Industrial and Special Economic Zones:

o   infrastructure and logistical advantages, such as electrical power, water supply, transportation, communications and waste treatment

o   Some of these infrastructure expenses are tax-deductible.

o   Easing restrictions on cross-border traffic of goods and labor to establish cross-border supply chains.

Trade Agreements.

·         Country Agreements.  Thailand is a WTO member and has free trade agreements with China, Japan, South Korea, India, Australia and New Zealand.

·         US Treaty of Amity.  U.S. owned businesses enjoy investment benefits through the U.S.-Thailand Treaty of Amity, originally signed in 1833 (This is the United States’ second oldest treaty!).  The Treaty allows U.S. citizens and businesses incorporated in the United States or in Thailand that are majority-owned by U.S. citizens to engage in business on the same basis as Thai companies (national treatment) and exempts them from most restrictions on foreign investment imposed by the Foreign Business Act.

·         ASEAN.  Thailand’s membership in the Association of Southeast Asian Nations (ASEAN) provides businesses in Thailand the advantages of the ASEAN Economic Community, a single market of more than 600 million people covering 10 countries in the region. This enables the free flow of goods, investments, labor and capital within the community.

·         China-ASEAN.  A China-ASEAN free trade deal also helps mitigate the trade-war risk for companies trading with both the United States and China.

Summary.

Is the time right for your business in Thailand? That depends on a variety of factors specific to your business, your industry and, most importantly, your goals. But is the time right for doing business in Thailand? Yes it is.

* John DiDominic spent seven years as a management consultant with the APM Group (Thailand’s leading domestic management consulting company) in Bangkok, Thailand and he has since focused on helping foreign companies navigate and do business in Thailand. For more than a decade, John has been our law firm’s go-to person for just about anything Thailand.

China lawyers

At least once a month someone will tell us that they don’t need a China-centric contract with their China-based manufacturer because their China-based manufacturer is owned by an American or a European company. To which I always say, “no it isn’t.”

Here’s the deal. No American or European or Australian company (or any other non-Chinese company) can own a Chinese factory directly. It is possible the American or European or Australian company that claims to own a Chinese factory owns a Chinese company (a WFOE maybe or a China Joint Venture) that in turns owns a Chinese factory, but the odds of this being the case are really slim. I don’t believe any of our China lawyers have ever encountered a foreign company that owns a Chinese company that owns a Chinese factory that does contract manufacturing for third party companies. Something like this is possible, but it is very rare.

So what does it mean when a foreign company claims to own the Chinese factory from which it is trying to get you to place your orders? This pretty much can mean one of the following two things:

1. The foreign company that claims to own a Chinese factory is flat out lying. It is amazing how often we see this and when I say “see this” I mean the foreign company puts in writing “that your products will be made by factories we own in China.” If you see this, you probably should run away.

2. The foreign company is fudging the truth. A lot. This occurs when the foreign company speaks of having your products made by “our factories” in China. If you push them on what they mean by “our factories,” they will usually state that these are the factories they have worked with for many years and know well and trust.

Why though does any of this matter? As someone whose law firm has been involved in many lawsuits on this issue, let me tell you it matters a helluva lot. It matters because companies that believe they are buying their widgets from an American or European or Australian company (hereafter referred to as the “AEA Company”) are (1) generally willing to pay more for the “safety” that comes from doing business with an AEA company, (2) generally willing to be super-relaxed about the contract they sign with the AEA company, and (3) super-relaxed about protecting their IP from China because they believe they are inherently protected because AEA law applies.

Unfortunately, the widget buyer could not be more wrong. The widget buyer now has a contract with an AEA company that has no legal connection with the Chinese manufacturer. The widget buyer has no contract with its Chinese manufacturer mandating the Chinese manufacturer deliver quality widgets on time and at a certain price and no contract with its Chinese manufacturer that prohibits the Chinese manufacturer from engaging in IP theft and no contract with the Chinese manufacturer that prohibits the Chinese manufacturer from selling your product to your customers. The AEA company also probably has no such contact with the Chinese manufacturer.

Almost invariably, if you give this sort of tripartite relationship 6-12 months, you will have problems that are extremely difficult or even impossible to solve. I will in my next post talk about the sorts of problems we frequently see in these situations.

 

 

Asia manufacturing lawyersPretty much every week or so in 2017, our China lawyers would get emails from companies asking us one of the following:

  • Can you recommend a good Chinese factory for me that makes ___________?
  • I am about to sign a contract with XYZ Chinese company. Can you please tell me what you know about them or at least whether they are legitimate?
  • How can I find a good Chinese factory that makes _____________?

In the last 3-4 months a slew of people have been asking our international manufacturing lawyers the following questions:

  • Should I be making my _________ products in China, Thailand, Vietnam or the Philippines?
  • Can you recommend a good factory in Thailand, Vietnam or the Philippines that makes _______?
  • How can I find a good factory in Thailand/Vietnam/the Philippines that makes __________?
  • Should I have a factory in Thailand/Vietnam/the Philippines make my products for my company or should I build my own factory in one of these countries?

These are all tough questions and I thought about them today after reading How To Get a List of “Good Chinese Factories”? by Renaud Anjoran over at the Quality Inspection Blog. Renaud starts his post by noting how “hardly a week goes by without someone asking me for contacts of “good factories.” Renaud and his company have been helping Western companies find and work with Chinese factories for well over a decade and yet he cannot answer this question and he gives the following as his reasons why:

  1. Confidentiality. Renaud’s company promises confidentiality to its clients and it therefore cannot share with other companies what they have learned by working with a client.
  2. Absence of bias. Renaud’s company audits and inspects factories on behalf of its clients and he worries about losing objectivity by recommending factories.
  3. There is no such thing as a “good factory in the absolute.” Renaud notes that what is a good supplier for one company may not be a good supplier for another company.

As a law firm, our perspective is different but similar and I will explain our position by answering the two lists of questions I set forth above:

  1. Can you recommend a good Chinese factory for me that makes _________? Just like Renaud, we do not know who is good at making XYZ product even if we literally just got off the phone with a client who told us how happy they are with their XYZ product manufacturer. Renaud is 100% right to say that a factory good for one company might not be good for another company. Renaud gives as an example a company that does a great job manufacturing for Apple because Apple is its best customer, but does a less than great job manufacturing for its smaller customers of which it cares far less. I have to admit that I wince whenever a client of ours says that “I know XYZ is a great manufacturer because they make the widgets for ABC company, which everyone knows makes the best widgets in our industry.” I’m tempted to say, “well yeah but it’s also possible that they are making the best widgets only because they are charging double what anyone else is charging and because ABC company stations ten quality control people at the XYZ factory 24/7 and does this make sense for you?
  2. I am about to sign a contract with XYZ Chinese company. Can you please tell me what you know about them or at least whether you think they are legitimate? Not unless you pay us to conduct due diligence on them. We are not going to put ourselves and another company at risk by just venturing a guess on a Chinese company.
  3. How can I find a good Chinese factory that makes ABC products? Answering this question is going to depend on countless variables. What do you mean by a good Chinese company? Are you looking for a company that makes ABC products that you can buy off their shelves? See Chinese Proprietary Product Purchase Terms. Are you looking for a company that makes ABC products that you can modify slightly to make your own? Are you looking for a company that will work with you in developing your own ABC products? See China Product Development: What You NEED To Know. How concerned are you with pricing? How concerned are you about quality? See China Manufacturing and How to Prevent Quality Problems Are you looking for a Chinese company that will not compete with you? See Your China Factory as your Toughest Competitor. What sorts of quantities are we talking about? Are you willing to pay a China manufacturing expert to help you find this factory? Are you going to want this China manufacturing expert to help you negotiate the contract manufacturing terms for you? Is anyone at your company fluent in Mandarin such that it makes sense for your company to do this search on its own? Does anyone at your company have extensive experience in outsourcing product manufacturing to China? I could go on and on, but the above should be enough to convince you that there is no one answer to this question either.
  4. Should I be making my ABC products in China, Thailand, Vietnam or the Philippines? This is a extremely important and complex question, to which the answer will depend on a whole host of factors that will be peculiar to your product(s) and to your company. We can give you the names of Asia manufacturing consultants with experience with this question but for us to do so, I should tell you that they will charge a minimum of $3500 to get started on this and in the end it will almost certainly cost you considerably more than that. If you are willing to pay this sort of money, we will make the connections.
  5. Can you recommend a good factory in Thailand, Vietnam or the Philippines that makes ABC? No, for the same reasons mentioned above as to why we cannot do that for China.
  6. How can I find a good factory in Thailand/Vietnam/the Philippines that makes ABC? The fact that you are asking me this question makes me think that you need expert help on this.We can give you the names of Asia manufacturing consultants with experience with this question but for us to do so, I should tell you that they will charge a minimum of $3500 to get started on this and in the end it will almost certainly cost you considerably more than that. If you are willing to pay this sort of money, we will make the connections.
  7. Should I have a factory in Thailand/Vietnam/the Philippines make my products for my company or should I build my own factory in one of these countries? This is an extremely important and complex question, to which the answer will depend on a whole host of factors that will be peculiar to your product(s) and to your company. We can give you the names of Asia manufacturing consultants with experience with this question but for us to do so, I should tell you that they will charge a minimum of $3500 to get started on this and in the end it will almost certainly cost you considerably more than that. If you are willing to pay this sort of money, we will make the connections.

The Bottom Line: Choosing the right country and manufacturer (be it you or a third party manufacturer) is both important and complicated. It is not something that can or should be determined via a five minute conversation with an international lawyer; it should usually be done by working with manufacturing experts that know the country or countries that might make sense for your industry and your company.

 

 

 

Apple works with a famous contract manufacturer (everyone has heard of them). The products they make for Apple are truly first class — in the millions of pieces, with very fast ramp up and pretty close to zero defect.

Well, that same manufacturer also produces batches (for other customers) that would not be acceptable for sale in Walmart or Testco, and sometimes even cheats on components. I know it because we have detected these issues while looking out for the interests of a client.

How is that possible? Well, on the one hand Apple’s business is something they value. And, perhaps more important, Apple spends a lot of efforts validating their production & testing processes before launching mass production, not to mention all their monitoring all along production.

If, on the other hand, an unknown buyer comes in the picture, gives them a 50,000 USD order, and patiently waits for delivery, they might be disappointed. A second- (or third-) rate team will work on your order, and totally different business rules will apply.

A small buyer, in that situation, is actually better off finding and vetting an unknown manufacturer that accepts to sign a balanced contract. Since there is no particular confidence in that manufacturer, the buyer takes precautions. Trust but make sure to verify.

 

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.

One of the most common questions our lawyers have been getting lately is “what should I do.” Mores specifically, we are getting this classic question from our clients that are making their products in China, either in their own facilities in China (that they own via their own China WFOE) or via third party contract manufacturers. They want to do what to do in light of the tariffs the United States is imposing on incoming China goods. More particularly, they want to know what more about non-China options.

I today read one of the best articles on what is happening out there with respect to US companies leaving China to manufacture elsewhere. The article is by CNN and its titled The trade war is pushing business out of China, but not into America and I like it so much because it 100% correlates with exactly what my law firm’s international lawyers are seeing and hearing, mostly from our own clients.

The article starts with the following:

US tariffs are prompting companies to move some production out of China, but it’s not going where President Donald Trump would prefer.

The trade war has made more than $250 billion of Chinese exports more expensive for Americans — from leather belts to refrigerators to motorcycles. The disruption to the world’s biggest trading relationship has electronics manufacturers, industrial machinery makers and fashion brands working on shifting some of their assembly lines.

“We are flooded by inquiries,” said William Ma, group managing director of Kerry Logistics, a Hong Kong-based firm that helps companies around the world manage their supply chains. “It all happens after the trade war.”

Many firms are keeping much of their operations in China, which offers a giant domestic market and advantages that businesses struggle to find elsewhere. But those that are moving aren’t flocking to the United States. Instead, they’re looking to transfer work to other Asian countries.

This is exactly what we are seeing. Many of our clients are moving their manufacturing elsewhere in Asia, many of our clients are “stuck” in China, and none of them have resourced their manufacturing to the United States, at least not yet.

The article then notes how “the tariffs have accelerated the shift of manufacturing from China to countries in Southeast Asia, where labor is cheaper.” and it uses the Steve Madden Company as an example of this:

Steve Madden (SHOO), whose handbags have been hit by a 10% tariff, says it’s moving a significant chunk of its production to Cambodia and other countries. The company currently makes about 85% of its handbags in China, a figure that could drop to 50% or 60% next year.

“The shift is almost entirely due to the US-China trade conflict,” Steve Madden CEO Ed Rosenfeld told CNN’s Alison Kosik. “We have to prepare as though tariffs will be the new normal, but we are hopeful that cooler heads will prevail.”

Again, this is exactly the sort of thing we are seeing from our clients whose products can relatively easily be made outside China; they are having some of their products made outside China. Only some because it just isn’t that easy or even possible to move all your production at once.

The article essentially says consumer tech brands are desperate to manufacture outside China and we are seeing the same thing:

Consumer tech brands are also looking to Southeast Asia. Hugh Lo, vice president of the consumer division at Taiwan’s New Kinpo Group, which makes electronics for clients such as Toshiba (TOSBF) and Samsung (SSNLF), says he has been inundated with inquiries from companies keen to transfer manufacturing out of China.

A year ago, his team got about one inquiry a week, he said. Now, it’s “maybe 30 times more.”
Lo said that TV and gaming device makers have been particularly interested in relocating. He declined to name individual companies.
Here’s the thing though; there just isn’t sufficient capacity for this outside China. Yet.
To what countries are manufacturers moving? The article nails this as well:
Nathan Resnick, whose San Diego-based startup Sourcify helps thousands of businesses place orders with manufacturers across Asia, has also noticed a clear shift away from China this year.
In January, Chinese factories supplied as much as 90% of the orders his company helped place in industries like textiles and household appliances. Now, he estimates that figure has plummeted to about 50%, with the focus moving to countries like Thailand, Vietnam and the Philippines.
“It’s really just been recently,” Resnick told CNN. “I didn’t go to any of those countries last year.”
Again, this is exactly what our international lawyers have been seeing as well. I estimate that among my law firm’s clients well over 50% of the production that is moving outside China is going to Vietnam and Thailand and the Philipines comes in third. Our clients looking to outsource their manufacturing are mostly favoring Vietnam and our clients looking to build their own manufacturing facilities are mostly favoring Thailand and the Philipines. We will see…
The article also rightly notes that leaving China is not easy and many cannot:
A lot of companies are unwilling to leave China, which has a range of advantages for manufacturing industries that are spread across Asia.
Many of the products US firms export from China have to fit exact requirements, necessitating specialized equipment and highly trained workers, according to Harley Seyedin, president of the American Chamber of Commerce in South China.
“Their supply chains cannot be adjusted in short order,” Seyedin told CNN.
China also boasts better roads, ports and power grids than most Southeast Asian countries. “China just has such a great infrastructure,” Resnick said. “You go to some of these areas in the Philippines or Vietnam, and the ground surrounding the factory is not developed whatsoever.”
Starting from scratch in another country is a major step.
Executives estimate it could take up to two years to build a new factory. Then there are the challenges of navigating the local bureaucracy and training new staff to meet the company’s standards.
One more big problem: many (most?) factories in countries like Vietnam and Thailand are bursting at the seams:  “Businesses that want to move their orders outside China face another problem: finding factories in the region that can accept them.” Our firm works extremely closely with well-qualified people in both these countries and so we know this problem is very real.
What are you seeing out there?

China manufacturing lawyers

For obvious reasons, Chinese manufacturing companies are incredibly concerned about the state of US-China trade relations and this worry seeping into how they view the Western companies for which they make products. In particular, this worry is leading many Chinese manufacturers to view their foreign buyers as likely to eventually leave them and that makes them less interested in doing what it takes to maintain a good long term relationship. For purposes of this post, it also makes Chinese manufacturers a lot more likely now than even a year ago to as quickly as possible purloin whatever they can from their Western buyer so as to be able to as quickly as possible compete with the Western buyer with the Western buyer’s own product.

The China lawyers at my firm have a front row seat to all this because we get emails from many Western companies whose products are being copied weeks after they first meet with a Chinese manufacturer. In the old days (of about a year ago), it usually took years and a deteriorating relationship between buyer and manufacturer before the manufacturer would start directly competing. In other words, Chines manufacturers used to wait until they believed they could make more money selling YOUR product than they could making your product for you before they would compete. Today, many Chinese companies have made the calculation that they can make more money selling your product starting on day one.

What’s all this got to do with mold ownership agreements? A lot.

One of the best ways to stop or slow your Chinese manufacturer from competing with you is by legally blocking it from using your molds for anything other than making products for you. There are a lot of ways to accomplish this, but oftentimes the best way is with a relatively simple mold ownership agreement that makes clear the molds belong to you, your manufacturer cannot use them for anything other than making product for you, and your manufacturer cannot hold on to them once you seek their return. For more on the benefits of protecting your molds (and tooling as well) from China, check out the following:

There are a whole host of other things you can and in many cases should be doing to protect against your own China manufacturer, but a mold agreement is oftentimes a good and relatively cheap start. See Protecting Your Product From China: The 101. 

What are you seeing out there?