China contract lawyerOne of the things I love about my work is the different sort of clients we get. Some of our clients care little to not at all about the rationale behind what we as lawyers do. Other of our clients prefer an explanation for everything. The other day, one of our China lawyers cc’ed me on an email she sent to a client who wanted to know more about the contract damages provisions (a/k/a liquidated damages) we had put into a number of contracts we had just drafted for this client. I am running that e-mail below (modified slightly) because it is relevant to most China contracts and therefore relevant for just about anyone doing business with China or doing business in China.

The PRC Supreme Court has ruled that contract damages are always subject to being adjusted to actual damages. Adjustment can be up or down, based on the facts. That is why we never provide for a contract damage amount that is high. We always draft  our contract damage provisions to comply strictly with the actual and foreseeable damages standard.

For the following reasons, we nearly always provide for contract damages (subject, of course, to the Chinese company on the other side going along with them):

1). Injunctive relief is extremely difficult to get in China.

2. One of the best ways to stop a Chinese company from infringing on your intellectual property rights (IPR) is with a prejudgment writ of attachment. But to to get that you need a reasonable standard for the amount of damage that will set the amount of the writ. Contract damages provides that reasonable standard. Though it may be adjusted later we draft them very carefully and conservatively and clearly so that is likely not to happen. The amount we specify in our contract damages provisions is both clear and fair and because of that it serves as a good basis for a prejudgment write of attachment motion.

3. Under PRC Supreme Court interpretations, contract damages is not a replacement for actual damages as proved at trial or as the basis for a final judgment. This renders the contract damages provision weak, but it does not render it meaningless because it provides the basis for the court decision on the damage amount. If the contract damage provision is reasonable and is based on a specific method of calculation that is ultimately based on an external fact (how many infringing items sold and their value), then it will be very unusual for a defendant to be able to convince a court to reduce the amount. On the other hand, if the contract damages is based on nothing or is clearly a penalty amount, the court will simply ignore it. When a court ignores the contract damages amount set forth in your contract, your having had such a provision does you more harm than good. See China Contract Damages: More Art Than Science.

For more on the benefits of contract damages provisions and how to draft such provisions, check out the following:

Vietnam manufacturing lawyerNearly four years ago — during a time when our international lawyers were seeing a big increase in Vietnam work from companies looking to diversify their manufacturing from China — I wrote a series of blog posts on sourcing product from Vietnam. Since that time, our Vietnam practice has steadily grown, until about five months ago when it exploded. In light of the rapidly increasing demand for information regarding sourcing product from Vietnam and in light of the dearth of such information, I am going to reprise and update those posts over the next few weeks.

This first post comes from March, 2015 and was — I believe –written from Ho Chi Minh City.

As my law firm’s Vietnam practice continues to grow, I have become fascinated with how companies decide on where to outsource their product manufacturing as between China and Vietnam, both for new products and for products currently being made in China. One of the reasons I am so fascinated by this is because so many factors must go into the decision and unless IP is paramount for the company, the legal issues are not usually central.

So I was delighted to read the post, 3 Key Factors for Sourcing in Vietnam, particularly since it is written by InTouch Manufacturing Services, a company I know to have substantial China sourcing experience.

That post starts out talking about how the media has been writing often of late about manufacturing shifting from China to Vietnam. It then notes that Nike now gets 42 percent of its product from Vietnam, as compared to 30 percent from China, widening the gap even since 2010. The post then presents the following wage chart from the Japan External Trade Organization showing that China factory workers make, on average, three times as much as factory workers in Vietnam.

Factory Wages in China and Vietnam

The post calls this wage disparity “significant for any labor-intensive product like footwear, garments, and electronics.” It is, but as I am always saying, if wages were the only factor, every company would be looking to start sourcing in Afghanistan, South Sudan or Yemen, and of course they are not.

Most importantly though, this post analyzes from a sourcing perspective the following three key issues involved in choosing between China and Vietnam.

1. Product Type. The post notes that “Vietnam has proven to be quite capable of producing labor-intensive products like footwear and is now starting to win over major technology companies for significant investments in more technical manufacturing.” However, though “capabilities and confidence in Vietnamese manufacturing are growing … China still maintains a significant competitive advantage.”

The post rightly warns those looking to shift production from China to Vietnam to consider “the risks posed by a [Vietnamese] workforce that is relatively new and inexperienced” and suggests asking “what might you be taking for granted in China now that you may find yourself struggling to manage or live without in Vietnam?”

2. Your Existing Supply Chain. The post rightly points out that Vietnam’s infrastructure is not as good as China’s and this could be particularly problematic for smaller companies that cannot essentially fund their own infrastructure:

Vietnam’s fragmented manufacturing industry makes it harder to identify suitable suppliers, especially for those new to Vietnam. Lack of basic infrastructure is a main cause of this fragmentation. Contrast that with China where you can find just about anything you want – and usually more than a handful of viable options that aren’t too far away from where you need them. With well-paved roads, 7 of the world’s 10 busiest shipping ports, and a massive network of high-speed and commercial rail lines, infrastructure in China is extremely well established.

*     *     *     *

Both countries pose their own unique challenges to foreigners looking to establish operations there, but the path is clearer in China. Tons of businesses have already set up shop and blazed the trail for mega corporations and small-time entrepreneurs alike. Potential foreign buyers and business owners of all sizes will have a relatively easier time finding guidance about China than for Vietnam.

This is very true and one of the things we are finding we are having to do for our clients looking to go into Vietnam is to connect them with appropriate people in Vietnam, far more often than we do for our clients looking to go into China.

3: Foreign-owned Manufacturers. The post discusses how so many of the “manufacturers in Vietnam established for export are actually foreign owned,” with a large portion of those owned or operated by Chinese or Taiwanese. Very true, and for more on that, check out this post, What’s Your Vietnam Strategy? on my time in Vietnam during last year’s anti-Chinese riots.

Interestingly, the post notes how this foreign ownership means that the time and energy you have spent “learning the nuances of Chinese culture and manufacturing will not have gone to waste. This makes it easy to transfer existing QC checklists, specification sheets, or other documentation that might have been written in English and Chinese. You’ll generally find that these factories also employ Vietnamese staff proficient in both English and Chinese.”

The post also wisely notes that with so many Chinese manufacturers themselves having set up in Vietnam, you should discuss with them how you “may be able to work with your Chinese supplier to keep some of the production processes in China, while outsourcing others.”

It makes for a really good read and I recommend you read it.

The same core things have remained the same for Vietnam, but there have been improvements on all fronts.

Product Type.  As expected, manufacturing in Vietnam is becoming increasingly sophisticated, to the point that it nears China standards for many products. Many of our clients that make clothing, shoes, furniture, doors and many sorts of housewares have been in Vietnam for years now, with great success and with rising manufacturing sophistication. Many of our clients that make kitchen appliances and electronics and more complicated household items (like door handles/locks) are either sticking their toes into Vietnam or are looking to do so.

Existing Supply Chain. China’s road and port transportation has improved since 2015 but it is still not even close to China in terms of capacity or reliability, especially for smaller companies. Vietnam has been discovered and even overrun with new manufacturing in the last few months and this is taxing its roads and its ports and its factories. Companies that have not experienced product delays in Vietnam for years are experiencing them right now and we expect that will only increase as more foreign companies that ship product to the United States (and even elsewhere) move production from China to Vietnam.

3: Foreign-owned Manufacturers. Still true. Many factories in Vietnam that cater to America and European and Australian companies are owned out of Taiwan.

One new thing about which you need to be careful these days is making sure your product made in Vietnam will actually be deemed to have been made in Vietnam for US tariff purposes. We are hearing of Chinese companies assuring their foreign buyers that they will ship their products to Vietnam (or Indonesia or Malaysia or Thailand or Hong Kong or Taiwan or Cambodia) and from there have them shipped to the United States and that doing this will make them “tariff free.” Having your made in  China products shipped to Taiwan or to Malaysia or to Thailand or to Vietnam or to anywhere else and then having those products shipped to the United States as though they are not from China can and does lead to massive fines and to JAIL TIME. Chinese factories are claiming either that this transshipping is either legal or that nobody ever gets caught, neither of which are remotely true. Do you really want to be legal advice about United States customs law from a Chinese factory with a massive incentive to sell you Chinese products and very little incentive to keep you out of jail?

US importers that falsely label the country of origin on their imports are subject to significant fines and penalties and to criminal prosecution. Lying about a product’s country of origin can subject you to 20 years in Federal prison. My law firm’s international trade lawyers are always pointing out that whenever the US increases tariffs on a product, the US Government knows there is an increased likelihood of illegal transshipping of that product and it prepares accordingly. The U.S. government is preparing to catch those who transship China products to avoid the new China tariffs and it will no doubt be tougher than usual on anyone they catch engaging in transshipping

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 stay out of jail. The Trump Administration has made known its desire to vigorously hunt down and prosecute transshipment claims.

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 US customs lawyer.

So though 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, you need to tread carefully and not 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.

For my first post comparing China and Vietnam, you need to go way back to 2006 and to Vietnam — Tastes Like China Lite.

I got a badly written and vituperative email yesterday in response to my post, On the Impact of China Tariffs: Is This a Dead Cat Bounce? In my post I predicted a large decline in manufacturing orders from China, starting in the next few months. The email accused me of “hating China” and wanting “to impede its peaceful” rise and of being “jealous of its progress.” All this because we have been writing of late how so many of our law firm’s own clients and so many others are leaving China, or looking to leave China. We have been getting quite a lot of these sorts of emails lately.

Guess what people. Our post about foreign companies leaving China have nothing to do with our feelings regarding China and everything to do with what we are hearing and seeing. Our statements of fact about companies leaving China are not being made out of animus to China, but out of a desire to tell the truth and help foreign companies figure out what to do about China going forward. Life would be far easier and economically lucrative for us if foreign companies were not running for an exit from China. But from what we see, they are.

We are telling the truth about companies (not just American companies) looking to leave China because part of what we do is help companies legally fulfill their goals and their plans. My firm’s international lawyers help companies negotiate their exits from China and we help companies figure out where to go instead of or in addition to China. We also help companies looking to set up in other countries, do deals involving other countries, protect their IP in other countries, and draft necessary contracts in other countries. In the last few months our international lawyers have been being kept nearly as busy with countries like Vietnam, Cambodia, Indonesia, Thailand, Malaysia, Turkey, India and Pakistan as with China.

The above is but an introduction to what we see as China’s diminished future for foreign companies. Since pretty much the inception of the US-China trade war we have been saying that we do not see its end because we have always seen it as more than a trade war. At first, we saw the US tariffs as an effort by the United States to get China to “open up” and “act right” on things like the internet and IP. But because we did not see China changing on these things, we did not see the trade war ending.

Vice-President Pence’s speech on China earlier this week has only reinforced for me that the trade war between China and the US will not be ending any time soon, if ever. The New York Times has called that speech the Portent of a New Cold War between the United States and China and China’s own Global Times wrote an article entitled, Pence speech shows Washington’s tougher policy on China. Don’t blame us. We are just the messengers. Things are getting very tough between China and the United States right now and the trade war is just a symptom of that, not the disease.

The United States is aggressively and unabashedly doing what it can to isolate China and to remove it from the world of international trade. The new free trade agreement between the United States and Canada is further proof of this as it essentially blocks Canada and Mexico from engaging in free trade with China. See What Trump’s new trade pact signals about China. Word is that shutting out China is going to become a regular thing in all new U.S. trade agreements. See US Commerce’s Ross eyes anti-China ‘poison pill’ for new trade deals. Will the EU and Japan and Latin America play ball on this? I predict that most if not all of them will.

So yes, the above is why we will continue to write about what North American and Latin American and European and Australian businesses should be doing to deal with the new normal regarding China. We are writing these things because we value our credibility and because we presume our readers value our no-holds barred advice — threatening emails or not.

For more on the new normal, check out the following:

And just in case you still believe we are saying the above for political not business reasons, here is your palliative: a great book that asserts the United States is blaming China for the US’s own ills: Blaming China It Might Feel Good but it Won’t Fix America’s Economy, by Ben Shobert, a good friend of mine. Ben — what are you seeing out there in terms of companies looking to leave and/or leaving China? 

What are you-all seeing out there?

So far nobody has written to factually dispute that many (most?) foreign companies are looking to leave and/or are leaving China, but we certainly would welcome such information if you have it! 

UPDATE: An international lawyer friend just sent me a link to this blog post by Renaud Anjoran over at the Quality Inspection Blog. Renaud heads up a top-flight quality inspection/product sourcing company out of Shenzhen, China, but his post was written from Vietnam and is entitled Transferring Production from China to Vietnam to Avoid Tariffs. Renaud’s post is essentially a how to on moving production from China to Vietnam. Does anyone believe Renaud went to Vietnam and wrote this post for reasons other than because his clients too are looking to reduce their dependence on China?


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.

We have of late been writing often about how so many of our clients are looking to move their manufacturing out of China and to places like Vietnam, Indonesia, Cambodia, the Philipines, Pakistan, Thailand and India. These posts are getting us more than the usual emails and way more angry emails than perhaps any topic ever on here. We get emails from people angry at us for criticizing China and we get emails angry at us for “continuing to act as though doing business with China is still viable for decent people.” We get it, but really all we are doing is reporting on what we are seeing.

My favorite emails though are the ones that essentially ask us how far we see this movement out of China going and how we see the US-China trade war ending.

My answers to both of these questions have so far remained pretty much the same and they are as follows:

I see a lot of foreign companies leaving China now and I see that exodus as continuing. It would hardly be an exaggeration to say that on at least one level, nearly all of our clients would — at least in theory — like to cease having their products made in China. Part of this is due to the hassles and the hard times they have gone through in China and part of this is due to the grass always being greener on the other side. But to a large extent, these (hurt) feelings are mostly irrelevant. What’s relevant is whether these companies can do their manufacturing in a country other than China and whether their company would be better off doing so. I think that in large part the answer to the second question will more often be yes than no but the answer to the first and more important part will more often be no than yes. Put simply, most of the companies currently having their products made in China have no choice. No country right now comes close to matching China for its combination of manufacturing sophistication and low cost and until this changes, the overwhelming bulk of companies having their products made in China will continue to do so.

I do not see an end to the US-China trade war and that is why I call it the new normal. I think that the US will not back down unless and until China truly opens up its economy and I do not see that happening. Instead I see the tariffs sticking and maybe even increasing. President Trump has said that trade wars are easy to win and it would seem he truly believes this. He believes he can only win this trade war with China because China will either back down or Western (especially US companies) will move their manufacturing out of China due to its increased costs. But see How to Lower your Product Costs, Part 1: This is China, for how China is lowering costs and for how you as a product buyer can take advantage of this. JP Morgan today forecasts that tariffs on all US-China trade and I see essentially the pretty much the same thing. See JPMorgan is now forecasting tariffs on all trade between China and the US — and it could cause havoc for Chinese stocks.

If you are going to up and leave China for another country, you will need the very same protections in whatever country you go as you need for China, but specifically tailored for whichever country to which you are going. This may include the following:

  1. An NNN Agreements before you reveal your product specifications or design or customers or any other trade secret.
  2. A Mold/Tooling Ownership Agreement if you will be bringing your molds or tooling from China to the new country or if you will be paying (either directly or indirectly) for new molds or tooling in the new country.
  3. Product Development Agreements if you will be working with your new manufacturer to modify an existing product or create a new one.
  4. Manufacturing Agreements with whomever new who will be making your product. Go hereherehere, and here for what that entails
  5. You will need to register your trademark to protect your brand name and your company name and your logo in whatever new country you will be going. This will likely be the most important thing you do.
  6. design patent or a utility patent
  7. copyright. Usually not needed, but when it is needed, it’s very important.

What are you seeing out there?

Any questions for next week?



China lawyers VAT rebateWith the onslaught of tariffs, many companies that import products into the United States are facing price increases. Our China lawyers are getting an earful about this from some of our clients, especially those that sell large chunks of their products to big retailers like Walmart and Target. On the other hand, our clients with super strong brand names and eye popping margins have for the most part not even mentioned the tariffs and their increased costs to us.

And yet, no matter who your downstream customers may be or what your margins are, now may be the best time ever to get your China contract manufacturing costs reduced, and our China attorneys are working with many of our clients to do exactly that. For many of them, we are working to help them diversify their manufacturing to countries outside China — so far this has mostly been to other Asian countries, such as Vietnam, Cambodia, the Philippines, Malaysia, Pakistan, India and Thailand, but also to Mexico and Eastern Europe and even to Canada and the United States — more so after the announcement of the “new NAFTA” agreement, a/k/a the USMC. Part 2 of this series will address the pros and cons of moving manufacturing out of China, to include a quick country-by-country analysis.

This post is going to focus on the steps you should consider taking now to reduce your China manufacturing costs.

In early February of this year, 1 dollar was worth 6.28 Yuan whereas that same dollar is worth 6.87 Yuan today, a nearly 10 percent increase. What this means in real life is that if you were paying your Chinese manufacturer $5 per widget in February and you are paying your Chinese manufacturer the same $5 per widget today, your Chinese manufacturer is making nearly 10 percent more today than it was yesterday, ignoring inflation, etc. What about you ask your Chinese manufacturer to at least share some of that 10 percent difference with you. I can tell you that virtually all of our clients that have made this request have gotten at least half of this savings back for themselves and many have pushed for and received all or nearly all of it. And for good measure, they are writing into their contracts that they get any future currency “savings” as well.

Our European clients are not “eligible” for quite the same savings, but seeing as how it was 7.41 Yuan to the Euro in mid-June and it is 7.88 Yuan to the Euro today (an approximate 6.5% increase) they too are “entitled” to not insubstantial price reductions as well.

But wait, there’s more.

Many Chinese factories (largely depending on the industry) will very soon be seeing fewer buyers and smaller purchases. How do I know this? I don’t know this for a fact, but I am virtually certain this will be the case. Last week, in On the Impact of China Tariffs: Is This a Dead Cat Bounce? I wrote about how business at my law firm is booming right now because so many companies are looking to move as quickly as they possibly can to get product made and out of China before tariffs further escalate and/or in time for the upcoming holiday season:

So for now at least our China practice and our international trade law practice are both booming and this state of affairs holds true for every China lawyer, every manufacturing lawyer and every international trade lawyer with whom I have spoken in the last three months. An old adage about lawyers is that we do well when times are good and when times are bad, just not when things are staying the same. That has been the case so far.

Not surprisingly, it is not just international lawyers at full capacity these days, American and European companies that do business with Asia (mostly) are seeing many choke points as well. We are hearing the following from our clients and our readers:

  • We are hearing that the Chinese government has increased the VAT rebate for exports from 13% to 16% to encourage more exports.
  • The RMB has depreciated and that means Chinese goods are cheaper than they were, further encouraging exports.
  • “Everything along the supply chain is at or near full capacity right now. We are hearing that both China and US West Coast ports are really busy and ships are full and shipping costs are rising.
  • The time for getting products from Asia through U.S. customs and getting products from the United States through China customs has greatly increased. This is due in part to the increase in shipment volumes, but also because customs officials in both countries are “going through everything with a fine-tooth comb” that comes from the other country. No surprise, right?
  • An old China hand friend of mine put it this way: “Prices are rising at every point. Tariffs, freight forwarding, shipping and trucking are all going nuts. It is one big clusterf–k.” He went on to say that he expects things to get considerably worse over the next few weeks because of the new and widespread tariffs and because of the upcoming Christmas/Holiday Season. “Everyone is and will be racing to get their products to port to avoid the possibility of more and increased tariffs in January; everything is going to go into hyperdrive like nobody has ever seen before.”
  • Our international litigation lawyers are already seeing an increase in disputes related to late delivery and shipping disputes.

I concluded that post with the following call for responses:

So for now, things are booming but for how long will this last? Will there be a crash in February or when or not at all?

What are you seeing out there?

And boy did I get it. I must have gotten nearly a dozen emails (roughly divided between people I knew and people I didn’t know) and pretty much all of them were at least somewhat angry and pretty much all of them talked of plans to move manufacturing out of China either as quickly as they could or at least within the next few years. I fully recognize that these emails are not anything close to being a scientific study and what highlights that is that not a one of them came from industries where I do not expect there to be much if any movement out of China in the next two years if ever — industries like electronics, biomedical devices, and pharmaceuticals to name just a few. But even if these emails were confined to only ten percent of industries, there is very likely going to be that move. My favorite email — both for what it said and because of who sent it (a 20 year China veteran and logistics guru who I know very very well) had this to say (modified slightly):

Companies are starting to move out of China already. A good friend of mine has a small business designing and selling high-end _______ in the US. He has been manufacturing them in Vietnam. He stopped making them in China a few years ago because labor costs had risen so much but they remain pretty low in Vietnam. He told me he was shocked recently when his Vietnamese vendor had to lengthen delivery schedules (for the first time) from four months to six months because it was swamped with orders that used to be filled in China before Trump’s trade war. Just one example of what you and I know is going to be an onslaught.

If you are a Chinese company that just lost a chunk of your business to Vietnam or to wherever, you are going to be more willing to reduce your prices than before these business losses started happening.

But Wait Theres More GIF - OxiClean ButWaitTheresMore HomeShopping GIFs

The Chinese government recently increased its subsidy of various exports via an increase in its VAT rebate. Go here for a good (but somewhat outdated) explanation on China VAT and China VAT export rebates. Very generally, China charges a 16% value added tax (VAT) on product sales but most product sales for export get a partial or full rebate of the VAT paid. A few weeks ago, China’s finance ministry announced that effective Sept. 15, “tax rebate rates for light-emitting diodes (LEDs), lithium batteries, multi-component semiconductors, machinery products, books and newspapers will be increased to 16 percent.” Reuters, and pretty much nobody else, carried this story in an article entitled, China to increase export tax rebates on 397 products:

The ministry, in a statement on its website, did not say what the current rebate levels are on those products. China assesses a 16 percent value-added tax on some exports, so a rebate of 16 percent will mean exporters get back the full amount paid.

“This is in effect to negate the impact from U.S. tariffs,” said Mei Xinyu, a researcher at a think tank affiliated with the Commerce Ministry.

For some other products, the rebate will be increased but not to 16 percent. According to the statement, China will increase rebates for stainless steel products to 9 percent and steel pipes to 13 percent. It was not clear immediately what the level of current rebates are.

Rates for chemicals also being increased, the statement said.

Exports are one of China’s key growth drivers, and any loss of momentum for them will pile more pressure on its already cooling economy.

China’s export growth has exceeded analysts’ expectations for the past five months, with some analysts believing Chinese exporters are rushing out shipments to beat fresh U.S. tariffs.

Last week, China’s state council said that it decided to increase the rate of export tax rebates for some products to support the economy.

Go here for the finance ministry’s announcement/list. This is in Chinese but if you go to the bottom of the page and click the part that says “xlsx” you will be able to download an excel spreadsheet that lists all of the items for which the rebate has been increased. If one of your products you have manufactured in China is on this list, you should figure out the rebate increase your manufacturer will be getting and you should consider asking it to “share” that rebate with you.

What all have you been doing of late to get your China manufacturing prices down?

California lawyers Proposition 65

Near as we can tell, nearly all IoT products are being made in China these days. And near as we can tell, most of those IoT products being made in China by foreign companies are being sold in the United States, and that includes California. It therefore bears mentioning that California Governor Jerry Brown last week approved SB-327, the first information security law in the U.S. specifically targeting the IoT.

SB-327 will take effect on January 1, 2020 and it will require manufacturers of connected devices — essentially, IoT devices — to be equipped with “reasonable” security measures. These security measures must be appropriate for the nature of the devices and for the information they collect and contain and they must be designed to protect the devices from unauthorized access, destruction, use, modification, or disclosure. SB-327 also requires devices that can be accessed outside of a local area network be equipped with either a unique password or allow its users to generate their own password.

It is important to emphasize that SB-327 does not impose any requirements on users of IoT devices, but rather on manufacturers. This will essentially mean that companies that manufacture qualifying devices may need to re-do or re-develop or maybe even re-invent their IoT products.

It is also important to note that this new California law will apply to more than just California manufacturers. It will apply to any business that manufactures — either itself or through a contracting third party — qualifying devices that will be sold or offered for sale in California. Crucially, there is no threshold number for product sales in California. Consequently, pretty much any manufacturer, anywhere, could be subject to SB-327.

Complying with SB-327 may be as simple as assigning randomly generated passwords to each of your IoT devices or re-tooling your IoT device’s software or firmware to provide more robust security protection. But for some manufacturers — especially those that make devices that gather up or contain sensitive information — compliance may be more involved and may require a ground-up reinvention. And because this is California, you should expect to be sued (and sued again) if you do not comply with these new laws.

Any company that has had to deal with California’s Proposition 65 knows whereof we are speaking here. Speaking of California’s Proposition 65, this is another California law of which companies that manufacture in China and sell into California must be aware. California’s Proposition 65 regulates any substance listed by the State of California as having a 1 in 100,000 chance of causing cancer over a 70-year period or birth defects or other reproductive harm. Businesses are prohibited from knowingly exposing individuals to listed substances without providing a clear and reasonable warning.

Here though is the big issue with Proposition 65: a company whose product may cause cancer (as defined per the above) may be sued by a private party for having such a product in California. What this means is that if you are having a product made in China (or anywhere else) and that product ends up in California, you are at risk of having to pay a lot of money to lawyers to defend against such a lawsuit and of having to pay the plaintiff in such a lawsuit a lot of money to make it go away.

And let me tell you, this is not just a hypothetical risk; I know this because my law firm’s Los Angeles and San Fransisco offices deal with these sorts of cases on behalf of our clients (American, European and Asian) all the time.

If you sell your products into the United States, you should figure that will include California and you should figure that you will need to contend with SB-327 and/or Proposition 65 and don’t say we didn’t warn you.

What are you seeing out there?

Editor’s Note: This post was co-written by Griffen Thorne, a cybersecurity lawyer based in our Los Angeles office.

Asia manufacturing lawyers

The key issues in nearly all the contract manufacturing agreements we draft (be they for China, Vietnam, Pakistan, Malaysia, Indonesia or wherever) are price, quantity and delivery date. Yet many foreign buyers fail to address these critical issues as they are more focused on issues like intellectual property protection and control of molds. They assume the basic business issues will take care of themselves. This is a mistake.

Here is what often happens. The foreign buyer does not know whether a particular product will “take off” or not so it enters a contract with its manufacturer that sets out the basic terms for purchase but does not mention any commitment on how much product it will purchase or when.

The buyer then makes small purchases of its product to determine whether there is a market for its product or not. The product then becomes a hit and the buyer returns to its manufacturer (in China, Vietnam, Malaysia, India, Indonesia or wherever) with a purchase order to buy substantial quantities of its product to be delivered just in time for the holiday season. The price and payment terms are the old terms set forth in the purchase order.  Based on that price, the buyer already has signed contracts with major retailers to provide its product in time for the holidays. The factory in Asia will be excited to receive the big order? Right? No, wrong.

Here are some of the more common responses we have seen from factories that refuse to accept a purchase order:

  • We have to increase the price. Raw material costs have increased. Our production costs have increased. From those first small orders we discovered that it is more difficult to make the product than we originally thought.
  • We don’t have the capacity to meet such a large order. Sorry.
  • To meet such a large order, we need to purchase materials, hire new employees, and expand our production line. To do all this, we will need you to pay a substantial deposit, much higher than the original deposit we required. We also need you to commit to a long term purchase agreement at terms favorable to us.

Since the factory is not required to accept the new PO, it is in control. If the foreign buyer does not agree, the factory can simply walk away. The factory knows all of this.

This situation can be a real disaster for the foreign buyer. In fact, for every one company we’ve seen bankrupted by IP infringement we’ve seen three bankrupted by missing out on an entire holiday sales season because they could not obtain product at a price, quantity and delivery date needed to satisfy their market.

Some foreign buyers will enter into an agreement where their factory agrees to locking in price for a specific period, believing this will protect them. They then think that they are covered. But this does not work because the factory still has the right to reject purchase orders.

This is because as a legal matter, it is unreasonable to require that a factory must accept your purchase orders without exception. What if your purchase order contains provisions never agreed to by the factory? There are an infinite number of possible conditions other than price. Quantity and delivery date are just the two most salient ones. Until you have an agreement with your factory on all relevant terms you have no “contract” requiring your factory fulfill your purchase order. If you submit your PO and your manufacturer accepts it, you have a contract: but only on the point of acceptance. Without your factory accepting your PO, you essentially have nothing.

Even on price, without an accepted purchase order or a binding commitment to purchase, no price lock from the factory is meaningful. The factory can always argue that a change in conditions requires an increased price. In many cases, this argument is legitimate. Since the argument may be legitimate, a court will not look deeper and the manufacturer will nearly always prevail.

Foreign buyers usually miss this fundamental issue: a PO is not a contract until it is accepted. Until the full set of terms has been agreed upon by the factory and the buyer, the factory will not be bound by a PO you submit to them. The factory is only bound bound by an accepted purchase order or a formal written contract that provides all the terms of the purchase transaction and for which the PO is just a formality. This is why my firm’s manufacturing lawyers so vehemently discourage our clients from operating on a per purchase order basis. A full contact is required. But a full contract requires a binding commitment to purchase a specific amount of product over a specific period of time.

Many foreign buyers are not in a position to make a hard commitment on product purchases What is to be done in that sort of situation? Very briefly, the below is what our manufacturing lawyers have proposed and had work.

1. The Asia factory agrees on a price lock period. This is never more than a year.

2. The foreign buyer gives a one year quarterly estimate of its purchase amounts and delivery dates. The factory has a period of time in which to accept or reject this estimate. This right to accept is the critical issue. If the factory has a problem with the rolling estimate, the factory is required to respond. If there is no response, the estimate is accepted.

3. The foreign buyer submits its PO to the Asia factory on a quarterly basis.

4. If the PO complies with the accepted rolling estimate and the price lock, the factory is required to accept.

5. We often provide that the foreign buyer has the right to adjust its quarterly PO up by 100% or down by 50%. This adjustment sometimes still requires the final purchase amount be within the annual estimated amount, sometimes not.

6. We have never tried to run this kind of program beyond the price lock period. If a price adjustment mechanism is included, it could run for a longer period of course. However, the factory is not obligated to accept a PO unless and until a final agreement is reached, and that final agreement requires the factory accept the rolling estimate.

Some factories accept the above and some do not. For most factories, the big issue is the price lock. The factory states that the price it is offering is based on the quantity and delivery date and if those change then its price changes.

The procedures for assuring your factory will accept your POs are complex, varied and variable. The key is that you as the buyer must face the issue and decide on how to proceed. If you do not do this, you likely will find yourself in a major jam right when your product is about to rocket to commercial success.

China lawyers
How to leave China and survive

Not surprisingly, our China lawyers are seeing a massive increase in foreign (mostly American) companies seeking to reduce or eliminate their China ties. Many are seeking to terminate their relationship with their Chinese suppliers and moving production elsewhere (so far, it’s been mostly Vietnam, Taiwan, Thailand, India and Malaysia). The other day I spoke with a company that has 50% of its manufacturing in China, 25% in Vietnam and 25% in Thailand and it wants to get out of China “as quickly as possible” but rightly afraid of just pulling up stakes and moving out.

Why is this company right to be so afraid and what are the risks for a foreign company seeking to leave China? Equally importantly, what can you do to mitigate those risks?

Way back in 2013, in The Single Best Way To Avoid Being Taken Hostage In China, we wrote of how Chinese companies and individuals often take hostages in an effort to collect on alleged debts or to protest employee layoffs or the closing of a China facility:

As the article states, “it is not rare in China for managers to be held by workers demanding back pay or other benefits, often from their Chinese owners, though occasionally also involving foreign bosses.”

My law firm’s advice every single time to our clients who are laying off workers in China or closing a facility in China or allegedly owing money in China is to stay outside China for all negotiations.  One only needs to be a regular reader of our blog to know that we took this position long ago and have never waffled:

  • If you are in a debt dispute with a Chinese company, the best thing to do is not go to China at all.
  • If you must go to China, think about using a bodyguard or two and think very carefully about where you stay and where you go. Most importantly, be very careful with whom you meet.
  • Consider preemptively suing the alleged creditor somewhere so that you can very plausibly claim that you have been seized not because you owe a debt, but out of retaliation for having sued someone. If you are going to sue, carry proof of your lawsuit with you at all times while you are in China.

By this point many of you are probably wondering why I am writing about debt when the issue is leaving China. My answer is very simple: once the news goes out that you will be leaving China, alleged creditors will come out of the woodwork. The tax authorities will come up with taxes that you owe. Your landlord will explain why you owe it way more than you thought you did. Your suppliers will send you bills for items they never actually gave you. Your employees will demand all sorts of severance. I am not saying these sorts of things always happen, but I am saying that they often do and you need to be prepared for it.

What about just shutting down in the middle of the night and walking away, never to return? That is always possible, but that itself comes with all sorts of risks and it virtually never makes even economic sense unless you are 100% certain that neither your company nor anyone who can be relatively easily identified with it will be doing business with China ever again and will never find itself in China ever again. As someone who has twice in his life been in an airplane that had to land somewhere other than its intended destination –(I once spent four unplanned January days in Magadan, Russia, when the city had essentially no fuel for heat) you should also be 100% sure you will never involuntary find yourself in the PRC. See also A China WFOE Shutdown, Baltimore Colts Style.

In a similar vein, we have also written previously on why you must prepare well in advance for terminating your China supplier. And by plan in advance, I mean you need to secure your molds and all of the product for which you have already paid before you do anything that might tip off your China supplier regarding your plan to start manufacturing elsewhere.

In How To Terminate Your China Supplier: Very Carefully, I discussed an article about a US toy company entitled, Jilted Chinese supplier tells would-be U.S. reshorer -“Not so fast,” that talks about how an American toy maker that brought a lawsuit in the United States against its Chinese supplier alleging its Chinese supplier had delayed deliveries to try to make it impossible for the American company to start making its toys in the United States. In my post, I noted that I had no idea whether the American company’s allegations were true, but “I do know it is common for Chinese manufacturers to seek retaliation against their foreign product buyers that cease buying product from them. For this reason, we instruct our clients to line up new suppliers [be they within China or in some other country) and have them ready to go before they even hint that they might cease production with their existing China suppliers.

We give this advice because over the years our China lawyers have repeatedly seen the following:
  • Foreign company tells its China manufacturer it will be ceasing to use China manufacturer for its production. China manufacturer then keeps all of the foreign company’s tooling and molds, claiming to own them. The way to prevent this is to get an agreement from your Chinese manufacturer that you own the tooling and molds before your Chinese manufacturer has any inkling that you will be moving on. For more on the importance of mold agreements, check out How Not To Lose Your Molds In China and Want Your China-Based Molds? You’re Probably Too Late For That.
  • Foreign company tells its China manufacturer that it will be ceasing to use China manufacturer for its production. Foreign company then learns that someone in China has registered the foreign company’s brand names and logos as trademarks in China. Foreign company is convinced its China manufacturer is the one that did these registrations, but it has no solid evidence to prove this. Foreign company is now facing not being able to have its product — at least with its own brand name — manufactured in China. Foreign company is also now faced with having to deal with a low cost Chinese competitor that can legally make products in China with the foreign company’s brand name and logo and sell those products anywhere in the world where the foreign company does not itself possess the trademark rights in its brand name and logo. The way to prevent this is to make sure your IP registrations in China are current before you reveal to anyone that you will be leaving there, or even just reducing your footprint there. See China Trademarks: Register Yours BEFORE You Do ANYTHING Else.
  • Foreign company tells its China manufacturer that it will be ceasing to use China manufacturer for its production. A few weeks later, foreign company has its products seized at the China border for violating someone’s trademark or design patent. The foreign company is (rightly) convinced that its China manufacturer is the one behind the product seizure, believing the Chinese manufacturer registered the foreign company’s brand names as trademarks in China long ago and is just now using that trademark to seize product as revenge (or just registered the design patent). China has laws forbidding its manufacturers from registering the trademarks of those for whom it manufactures, but because it is usually not possible to prove that your manufacturer in Shenzhen had a cousin in Xi’an do the registering, this sort of thing goes on unchecked. For how to prevent this from happening to you, check out the following:
  • Foreign company tells its China manufacturer that it will be ceasing to use China manufacturer for its production. China manufacturer then says that it will not be shipping any more product because foreign company is late on payment and owes it hundreds of thousands of dollars. China manufacturer then reports foreign manufacturer to Sinosure and Sinosure then ceases to insure product sales to this foreign company, which can have the effect of convincing other Chinese manufacturers not to sell to foreign company without getting 100% payment upfront. For more on Sinosure’s role regarding China exports, check out Be Sure Regarding China’s Sinosure. Note that if you are planning to move your business to a country other than China Sinosure’s power over you will be greatly diminished

To increase your chances of surviving a move out of China, analyze your weak points and do what you can to minimize those. Above all else, plan ahead and act with all deliberate speed.

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?