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Dan Harris is internationally regarded as a leading authority on legal matters related to doing business in China and in other emerging economies in Asia. Forbes Magazine, Business Week, Fortune Magazine, BBC News, The Wall Street Journal, The Washington Post, The Economist, CNBC, The New York Times, and many other major media players, have looked to him for his perspective on international law issues.

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 getting paid

Our China lawyers have been getting a rash of emails lately from foreign companies (mostly from Northern Europe!) that need help in getting paid. These foreign companies typically provided services to Chinese companies and they are not getting paid for having done so. The below is an amalgamation of a few such emails we received:

We have a company registered in Denmark and we recently introduced a client with a large project to a Chinese company. It was agreed that our company would receive a commission for this introduction, to be paid to our Denmark bank account. The Chinese company is now claiming that we first must pay the taxes on the commission and they do not even know how much those taxes will be. We are not resident in China (our company has no office in China) and we will need to pay taxes on our company income in Denmark. Is what this Chinese company is saying accurate or are they are just trying to cover some of their tax liabilities by deducting an amount from our commission fee or are they using this as a ploy not to pay us at all? How much in taxes will we need to pay?

Our response is usually something like the following:

Probably yes to all of your questions. What they say is almost certainly true, especially if you do not have a written contract or if your written contract is not a Chinese appropriate contract or it does not make clear who should pay the taxes or it was not written with taxes in mind. All of this means there is a good chance your company will be out a substantial amount of money here. How much will depend on what exactly your contract says the payments are for but it could be 40% of whatever you are owed. Even worse, if your contract or your invoices were not drafted properly (and I fear they were not), you may never get paid anything. Your Chinese counter-party will likely act as if it is concerned about paying you but odds are that it would like nothing more than to be able to hide behind all of this Bank of China and tax stuff to never pay you. I apologize for adding to your problems but I am also concerned that the Chinese government will view you as having done sufficient business in China such that your not having a Chinese company has put you and others at your company at serious risk. For this reason, I strongly urge that nobody from your company go to China unless and until these various company and tax issues are resolved. For more on all of this, I urge you to read the following:

About half the time the companies that contact us with this problem come from one of the following Northern European countries: Denmark, Norway, Sweden, Germany, Switzerland or Finland. On top of this, a grossly disproportionate number of the frantic calls/emails we get from companies facing major tax problems in China come from those same countries. Since less than 10 percent of our client base is from those countries (because we have a Germany licensed lawyer, this number is relatively high) the “in trouble” phone calls we get from Northern European companies are way out of whack to what they should be. Why is this the case? I will quote from a China consultant friend of mine from Denmark:

We are not so used to using lawyers for our deals and we are used to trusting governments and getting help from them. Also, we have a tendency not to believe the Chinese government operates efficiently or fairly and so we think that they can and should be avoided.

I don’t know if this China consultant is right, but in my experience Northern European companies both fail to use lawyers enough to avoid problems in China and fail to take sufficiently seriously the problems once they happen.

What have you seen out there?

China US cold warThe air is getting hotter
There’s a rumbling in the skies
I’ve been wading through the high muddy water
With the heat rising in my eyes

Everyday your memory grows dimmer
It doesn’t haunt me like it did before
I’ve been walking through the middle of nowhere
Trying to get to Heaven before they close the door

When I was in Missouri
They would not let me be
I had to leave there in a hurry
I only saw what they let me see

You broke a heart that loved you
Now you can seal up the book and not write anymore
I’ve been walking that lonesome valley
Trying to get to Heaven before they close the door.

When you think that you’ve lost everything you find out you can always lose a little more.

The above is from Nobel Prize Winner Bob Dylan’s song, Trying to Get to Heaven, and I apologize for quoting so much from it, but it is just so spot-on regarding the US-China cold war.

In early October, in one of our Quick Question Friday posts, we wrote about how all companies that sell Made in China products to the United States need to recognize there will be no quick end to the US-China trade dispute and to start preparing accordingly. This post led to more than the usual volume of hate mail, most of this coming from second-tier “China consultants” who prefer to blame this blog for putting their China gravy train at risk, rather than the downslide in China-US relations doing that.The below is the key portion from that Quick Question post:

My favorite emails though are the ones that essentially ask 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.
According to this Report, China has made clear — both in public statements and in government-to-government communications –-that it will not change its policies in response to the initial Section 301 action. Indeed, China has largely denied there are any problems with its policies involving technology transfer and intellectual property. The report goes on to note how China’s State Council issued a 71-page “White Paper” in September 2018 that dismissed the Section 301 investigation’s findings and denounced U.S. actions as “trade bullyism” and how China has attempted to harm the U.S. economy by increasing duties on U.S. exports to China.

In other words, “deny deny deny.”

According to the USTR, these actions reveal that the initial tariffs are “no longer appropriate to obtain the elimination of China’s unfair trade acts, policies, and practices. In addition, the burden or restriction on United States commerce of these acts, policies, and practices continues to increase, including following the one-year investigation period. Accordingly, under direction of the President, USTR imposed additional tariffs on approximately $200 billion of imports from China on September 24, 2018.”

I see this “no longer appropriate” phrase as meaning that the U.S views it must do more than just impose tariffs on Chinese goods entering the United States. Like it or not, we see the United States engaging in some or all of the following against China:

  1. Increasingly block Chinese investment into the United States.
  2. Seek to have China removed from the WTO.
  3. Seek to block high end technology from going to China. See the just released proposed Federal rules for accomplishing this.
  4. Seek to isolate China as much as possible. We see a situation where the Untied States will be presenting the world with a “you are either with us or against us” situation similar to the US-Russia cold war.

In light of the above, we think it wishful thinking to believe the upcoming G20 meeting between President Xi and President Trump will do anything to ease US-China tensions and if we had to predict, we see that meeting only exacerbating the situation, much as the recent APEC meeting did. There can be no resolution on matters that are 100% denied by one side.

We take no pleasure from the above as China has been a massive part of our law firm’s Asia legal practice over the last two decades — we started this China Law Blog in 2006! But at the same time, as international lawyers we too need to remain nimble and we now focus as much on the rest of Asia and on Europe as on China. What are you doing to prepare for the above? See Would the Last Company Manufacturing in China Please Turn Off the Lights. Where will you be going? Thailand? Vietnam? The Philipines?

China Law Social MediaWhen we first started writing this blog we were more free-wheeling than we are today for one very simple reason. The odds of our our having problems with the Chinese government were a lot less back then, though there were definitely times where we would “go blank” in China for weeks at a time for having crossed some arbitrary and capricious line. For a whole host of reasons we want to stay live in China and so — like many others — we have toned down and learned not to walk too close to various lines. We don’t like this one bit but this is the China world in which we and everyone else lives.

We don’t have that same line on Facebook or Linkedin or Twitter.

And so we have ramped up what we do on social media. We have a thriving China Law Blog Group on Linkedin that serves as a 99.99% spam-free forum for China networking, information, and discussion. This group is always growing and we are now less than 100 members short of 12,000.

More importantly, we have had some great discussions there, as evidenced both by their numbers (we’ve had discussions with 50-100 comments) and their substance. Our discussions range from people asking and trying to answer questions like, “why is it so difficult to do business in China” or ”what do I need to do to get my Chinese counter-party not to breach my contract” to the ethereal, like “when will we know China is taking innovation seriously?”

The group is nicely split between those who live and work and do business in China and those who do business with China from the United States, Australia, Canada, Europe, Africa, the Middle East and other countries in Asia. Some of our members are international lawyers but more than 90 percent are not. We have senior level personnel (both attorneys and executives) from large and small companies and a whole host of junior personnel as well. We have professors and we have students. These mixes help elevate, enliven, and enlighten the discussions.

What truly separates us from most (all?) of the other Linkedin China groups is how we block anything and everything that even smacks of spam. We have become so proficient at not allowing spam to show up on the discussion page that it is the rare person who even tries to tempt fate by trying to sneak anything past us anymore. This means postings are relatively rare there (1-2 a week) but this also means it will not waste your time.

If you want to learn more about doing business in China or with China, if you want to discuss China law or business, or if you want to network with others doing China law or business, I urge you to check out and join our China Law Blog Group on Linkedin. The more people in our group, the better the discussions, so please go here and join us!

My personal Linkedin page has more than 8,500 followers and in response to that I have started posting more often there on China, though still a bit irregularly. I welcome any new followers, especially as I plan to start posting more often there (even if it is only to share some of the truly great stuff that others are posting on Linkedin about China.

Our China Law Blog Facebook page, which until only fairly recently was little more than an afterthought, has more than doubled its followers in less than a year. It has more than 23,000 followers (I base this on its number of “likes”) and it is the rare post that does not engender discussion, often heated. With no government there to restrain us, we can be a lot more free-wheeling there than anywhere else and we do take advantage of that. With all the tension that has been going on between China and the US these days (much of which cannot be discussed here without repercussions) our Facebook page has truly become a key source for helping to figure out what is happening. It also has its lighter side as we often will just post cool pictures of China there or really whatever strikes our fancy about China. I urge you to go there and “like” us so you can consistently benefit from what we are doing there.

I am also on Twitter (here, as @danharris) though I am there more to learn than to post.

See you online….

international trade lawyers

Give it a few months and the Trump tariffs are likely only going to get worse. I say this not just because I am convinced they will eventually increase and spread to nearly everything coming from China, but because I am convinced far too few SMEs understand them sufficiently.

I say this based on a multitude of conversations the international lawyers have had with American and European companies about the tariffs and about how to avoid the tariffs. When it comes to the tariffs it is surprising how many companies that ship their products to the United States do not know whether the tariffs impact their products and have no idea that more tariffs could be coming early next year. We are hearing from companies that are looking to start having their XYZ widgets made in China and when we ask them whether they have looked to any countries other than China for this brand new manufacturing, they ask us “why?” And when we tell them that many of our clients are already having their XYZ widgets made in such and such a country (usually Vietnam, Thailand or the Philipines) to avoid the China tariffs, they are completely surprised. In other words, despite the tariffs on goods from China it had not occurred to them to have their products made anywhere other than China. This is particularly true of European countries, who in general seem only very vaguely to be aware of the tariffs at all.

This is part 3 of our series on what to do about the trade tariffs President Trump has been imposing on goods from China. Go here for Part 1 of this series and here for Part 2.

This U.S. Government website sets out U.S. import duties and it would behoove you to understand all parts of it that are relevant to your actual or planned US imports and to understand also how your actual or planned US imports are likely to be impacted come early next year. What will happen to your sales if your products are subject to a 25% tariff and your competitors’ products are not? And all of this is way more complicated than just knowing whether your products will be hit by or escape the China duties; this also requires you know whether your products will come in duty free from Thailand or be subject to a 7% duty (or whatever) from Vietnam. I mention this because generally (though certainly not always) duties from Thailand and the Philipines are lower than duties from Vietnam, so even in choosing which non-China country you are going to use for your manufacturing, you need to know your way around the duty charts.

To further complicate things, we are hearing from and about far too many companies who believe they can avoid the China tariffs by having their products essentially made in China and then shipped to some third country to have it “finished” and then shipped from that third country to the United States. This may be as likely to land you in jail as it is to avoid the China tariffs. I wrote extensively on this in China Tariffs and What to do Now, Part 1:

But before I discuss what companies do about their tariff problems, it is far more important I start out discussing what they should NOT do. They should not have their China products shipped to Taiwan or to Malaysia or to Thailand or Vietnam or anywhere else and then have those products shipped to the United States as though they are not from China. Doing this sort of transshipping can and does lead to massive fines and to JAIL TIME. I am not kidding. I am starting out with a post on what not to do because the risks from this one thing far exceed the benefits of the things we will be discussing in our subsequent posts.

And yet, many are telling us that their Chinese factories are suggesting these exact sort of transshipments and giving assurances that they are legal or that nobody ever gets caught, neither of which are remotely true. Step back for just a second and ask yourself why you are even considering taking legal advice about United States customs law from a Chinese factory owner or salesperson who has all the incentive in the world to sell you Chinese products and very little incentive to keep you out of jail. Please, please, please don’t fall for that. Please.

Chinese companies and the U.S. importers of their products often believe they can get around United States tariffs  by transshipping the products to Malaysia, Vietnam, Philippines, Sri Lanka, Thailand, Bangladesh, India, [or some other country] before sending them on to the United States. Their plan is to relabel the products with a new country of origin and then export the products to the US free of China , without US Customs and Border Protection (“CBP”) ever being the wiser.

So wrong.

US Customs has become expert at discovering such evasions and the penalties when caught have become very harsh. Importers that knowingly falsely label the country of origin on their imports are subject to significant fines and penalties under 19 USC 1592 and to criminal prosecution under 18 USC 542 (import by using false statement) and 18 USC 545 (smuggling). Lying about a product’s country of origin can subject you to 20 years in Federal prison.

Immigration and Customs Enforcement (“ICE”) has conducted criminal investigations against a number of products, including honey, saccharin, citric acid, lined paper products, pasta, polyethylene bags, shrimp, catfish, crayfish, garlic, steel, magnesium, pencils, wooden bedroom furniture, wire clothing hangers, ball bearings and nails. Many of these investigations have led to criminal convictions and large fines and penalties. U.S. importers have also been prosecuted and sentenced to prison for bringing in Chinese products, such as honey, garlic, wooden bedroom furniture and wire clothing hangers, by means of false Country of Origin statements so as to evade US AD and CVD orders. My law firm’s international trade lawyers are always pointing out that whenever the US increases tariffs on a product, it knows there is an increased likelihood of illegal transshipping of that product and it prepares accordingly. There is zero doubt the U.S. government is preparing to catch those who transship China products to avoid the new China tariffs. There is also zero doubt that both the U.S. government (and even the U.S. populace as a whole) are going to be tougher than usual on anyone who engages in transshipping

United States CBP, ICE and the Justice Department can be very tough investigators and prosecutors.

One of the biggest hammers against transshipping is the False Claims Act (“FCA”).  The FCA ( 31 U.S.C. § 3729) allows people or companies to file what are called “qui tam” lawsuits against individuals or companies that directly or indirectly defraud the Federal government seeking triple damages on the government’s behalf. Anyone who knows of the fraud, including a competitor company may file a qui tam lawsuit. And they do.

Qui tam actions are brought to attack competitors and to get 15 to 30 percent of the triple damages the U.S. Government can recover from the lawsuit. Your competitors and your importers and your own employees (and even employees of the Chinese company that has assured you that your transshipping is perfectly legal) are the most likely to initiate a qui tam lawsuit against you, but sometimes it is just someone who learned of what you are doing. Because the person or company that brings such an action can be awarded millions and even tens of millions of dollars, the incentive to file is huge. If you want to get a better idea of just how lucrative these lawsuits can be, do a Google search for lawyers looking to take on qui tam lawsuits and look how much they are paying for qui tam keywords.

Qui tam lawsuits are filed confidentially and are not served on the defendants, but on the US Government. The US Government then determines whether to intervene and pursue the action or settle with the defendant(s). If the U.S. Government intervenes, it takes on primary responsibility for the case. If the U.S. Government decides not to intervene, the initial claimant may dismiss the lawsuit or pursue the lawsuit on its own.

What is your duty as the US buyer/importer to make sure the products you are importing are truly from the country listed on the import documents?

The examples below are illustrative.

  • A US importer is told by its Chinese producer/exporter whose products will be covered by the China tariffs not to worry about the tariffs because the Chinese company will ship the product through Taiwan and list them as Taiwan products. The importer should decline this offer because if it imports this product knowing it is from China and not Taiwan, it will be criminally liable under U.S. customs law and subject to potentially massive damages under the U.S. False Claims Act. 
  • A US importer suspects its Vietnamese “producer” is not actually making anything, but rather simply transshipping product that comes from the Chinese company that owns it. The company visits the Vietnam facility and it does not appear anything is actually being produced there. The US importer raises this concern with the Chinese company which tells the US company that it can avoid any problems by being listed as the consignee of the products and not the importer of record since it is the importer who is at risk. This too is simply wrong information.

Transshipment is a crime and Chinese companies and their US importers can have very different interests when it comes to importing product into the United States. The Chinese company wants to ship product to the US above all else and the US importer should above all else want to avoid Customs trouble and avoid liability and stay out of jail. The Trump Administration has made known its desire to vigorously hunt down and prosecute transshipment claims.

If you are doing business with a person or company using transshipments to minimize US customs duties, you could be in very big trouble and you should contact a lawyer immediately. If you are aware of such transshipments by a company with which you are not doing business, you should consider contacting a lawyer to determine whether you might profit from your information.

Here’s the thing though. There is often a lot you can do to legally change the country of origin of your products, but the key here is legally. The other key here is that the rules for figuring out the appropriate country of origin are incredibly complicated and best left to an experienced and qualified international trade lawyer, especially in light of all that is going on between China and the United States these days.

If you are going to take your made in China product and have it made partially in some third country and then have that product qualify as having been made in that third country and not China, that product will need to be “substantially transformed” in that third country. One of my law firm’s international trade lawyers describes the substantial transformation requirement as follows:

Substantial transformation dictates that a product consisting of components/materials from more than one country is a product of the country where the components/materials become a new and different article of commerce with a name, character, and use distinct from that of the components/materials from which it was transformed. The CBP makes its substantial transformation decisions on a case-by-case basis, though U.S. importers may seek advance rulings on origin covering specific products for import.

The rules for what constitutes substantial transformation are anything but clear-cut and the country of origin for your products should be determined on a case-by-case basis by a qualified international trade lawyer.

 

 

 

 

 

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

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?

 

China lawyers

Our China lawyers get a steady stream of emails from companies seeking our help in recovering money lost in China scams or just telling us about the scams and asking us to report the scammers to “the police, the government, the State Department, the Embassy, and/or the consulate. Many of these emails also request that we write about the particular scammer on our blog or on our China Law Blog Facebook page.

Less than one percent of the time we probe a little further to see if there is any chance at all of a financial recovery, and we do so only in those matters where the losses are in the six figures or higher. We never report anyone to anyone and we never name names here on the blog.

Why not?

We don’t report anyone to anyone because if we did so we would be spending hours a day doing so and all without pay. We cannot just take what someone tells us and go to anyone with it as their lawyers. Our job as lawyers is to do our best to determine what is true and what isn’t and to dig into the facts to come up with as much as possible that might be helpful to government and law enforcement authorities in finding the culprits. Equally important, I have serious doubts that any government body in any country does much with these scams. So instead we tell the writers that they should do these things on their own.

Why though do we not name names here on the blog? Why don’t we have a list of scammers on here? For the following two reasons.

In many cases of alleged fraud, it is not clear at all that there has been a fraud. Here is one recent example. A Mexican company bought $60,000 in t-shirts from a Chinese clothing company. The Chinese clothing company sent the requisite quantity of t-shirts and the Mexican company alleges that they were of such poor quality as to be a scam. Was it a scam? I have no idea. Did the Mexican company have a written contract with the Chinese company specifying the quality of t-shirts it would be buying? I have no idea. Did the Mexican company spend $10 per t-shirt or $1 per t-shirt? I have no idea.

In many (most?) cases of alleged fraud, the name of the company is NOT the company that committed the fraud. Fraudsters often claim to be with a particular legitimate Chinese company but they really are not and a quick check of their email address reveals this. Guess what, people. It is extremely unlikely that a legitimate Alibaba employee will be emailing you from a qq email account. Many times the person behind the fraud is not Chinese and is not based in China; they are simply claiming to be with a Chinese company to pull off the fraud. We are not going to list company names when we have zero clue whether the names of the companies listed had anything at all to do with the alleged fraud.

I do note though that there are many sites that do name names and it does make sense to do an internet search before you send it money. Indeed, in most cases, additional due diligence is warranted.  See China Business Due Diligence.

Your thoughts?

China laws and business are very different from the West, of this there should be no dispute. China lawyers

And yet, our China lawyers oftentimes get emails from potential clients telling us that they have drafted a contract for China and asking us whether we would revise that contract to “make it work for China.” Our initial response to this is to say yes but to warn them that our fees for doing so will almost always be the same as our fees for our drafting the contract from scratch. The reason for this is because, with very few exceptions, the contract we are given is so different than what is required for China that its only benefit is that we can pull some (never all) of the terms we need for drafting the contract.

But guess what, that benefit almost never outweighs the harm. Let me explain.

Much of the time when we are given a draft contract that contract is a result of weeks of negotiations between the Western company and the Chinese company. If our China attorneys then substantially revise the contract and our Western company client then sends the substantially revised contract to the Chinese company, the Chinese company is rightly irritated because it believed it had a deal or was on the verge of a deal with the Western company, even though it really wasn’t.

But most of the time, the draft contract we are given is so far afield from what is needed that instead of our China lawyers being able to draft a new contract, our China lawyers instead have to tell our client that it really needs to start back at square one. Most of the time the draft contract we are given is so internally contradictory and so rife with provisions that literally do not work at all under China’s laws, that the first thing we need to do with our client is figure out exactly what it is trying to accomplish with the deal.

And then, once we have that figured out, the next step is usually to draft (in English and in Chinese) a term sheet to send to the Chinese company to determine whether drafting a contract will ever be warranted. Oftentimes, there is a critical provision that the Western company and the Chinese company never previously discussed and on which they are at clear loggerheads. The term sheet quickly reveals this and the parties then choose to go their separate ways. Oftentimes, there is a critical provision that simply cannot legally work and without that provision one or both sides do not want to go forward with the transaction and the parties then choose to go their separate ways.

We see these sorts of looming problems so often with draft agreements that I have drafted the following “template” explanation, which I then modify to fit the particular situation:

We reviewed the draft contract you sent us and we think it premature to begin drafting a contract based on it. Some of it is contradictory, some does not make sense, and some is almost unworkable or illegal. It also fails to address critical deal terms.
What we need to do here is to work with you to figure out what exactly you are seeking to do and then use that to determine whether the Chinese side will be on board with that or not. Once we are clear on what you are seeking to do here, we then draft a term sheet in English and in Chinese and use that to see whether a deal is possible. If a deal is possible, we then move forward on drafting the contract. If it is clear that no deal is possible on your terms, you then determine whether you want to compromise or walk away.
We will charge considerably less to develop the term sheet than we would charge to draft a full-fledged contract. This means that If it turns out no contract is warranted, you will have saved quite a lot of money. If it turns out a contract is warranted, much of what we will have done to develop the term sheet will apply to what we will need to do to draft the subsequent contract.
The above is our advice, but obviously what you do is up to you in the end.
Please let us know.

China Law Professor Donald Clarke sent me a great article this week from New York Magazine, entitled, How China Drove Out Mister Softee. Professor Clarke’s email with the link said the following:

Thought you might like this. Interestingly, it is NOT a story of “guy skirts rules, naively trusts Chinese partner, gets screwed.” It’s “guy does everything absolutely by the book, has reliable Chinese partner who does not screw him, and still gets screwed by changing political atmosphere.” For him to get competition eventually is quite normal, and the competition wasn’t using a trade name similar to his. But the rules were not evenly enforced.

This is the sort of story I both love and hate. I love this sort of story because it is interesting and important but I hate it because I constantly and aggressively stress to my clients the need to follow China’s laws to the letter and with that I ought to be able to tell them that by doing so they will have no problems. I also hate this sort of story because it reveals the cynical truth that the reality is really more the opposite: if you do not follow China’s laws you will have a problem. If you do follow Chinese laws the odds of your having a problem will go way down, but hey, it is no guarantee. Truth is that as a foreign company doing business in China you will be a target and this means you must follow the laws to avoid being an easy and legal target but even if you do follow the rules you are still a target.

Quick aside. Why the Jim Carey clip about “messing with the doo?” Two reasons. One, It’s just a great clip. And two, I love soft-serve ice cream and I have fond memories of eating Mr. Softee ice cream when visiting my grandmother in New Jersey. So I see China’s messing with Mister Softee as the equivalent of “messing with the doo.” But I digress.

So if you read the New York Magazine article, you will learn that Turner Sparks brought New York’s iconic Mister Softee trucks for the first time to China” back in 2007 and eventually built his ice cream empire to ten trucks and 25 employees in Suzhou. You will also learn the following:

Mr. Sparks did local TV and newspaper interviews and was a fixture at school and corporate events, where he and his team doled out waffle-cone soft-serve to thousands. During one corporate party at Bosch, an international electronics company, he sold $9,000 worth of $1 cones in just two hours.

Competition was scarce, because he essentially invented the Suzhou ice-cream-truck market. “All these trucks were just going nuts, doing really well. Huge lines all the time,” he told me. “Everyone knew Mister Softee.”

He planned an ambitious expansion, and lined up investors to back it: He wanted to quintuple his fleet to 50 trucks, add more storefronts, and move into new territory.

More importantly, you will learn how tough it can be to do business in China, because you will learn that instead of expanding his business in China, Mr. Sparks ended up leaving China “with just enough money to reinvent his life as a New York stand-up comic.” and that “what happened to Sparks is an illustration of how the landscape has shifted for foreign businesses in China since current premier Xi Jinping has taken over the country, and the climate has become considerably less hospitable for foreign business — small ones, in particular.”

The article talks about how things began to change for foreign companies in China starting in 1978 and how Sparks was able to build up his ice cream empire:

They created a local supply chain from scratch, finding vendors for cones, straws and soft-serve mix at a Shanghai food-and-drink expo. Using secret blueprints from Mister Softee, the truck was built in Nanjing by a company that makes telecommunications trucks, armored vehicles, and ambulances. Workers were hired from a job fair, with many long-distance drivers jumping on the opportunity to work locally and try something different. To give the soft-serve the same taste as back home, they shipped the milk in from the U.S.

Suzhou officials worked with Sparks to create a new kind of business permit for their ice-cream trucks, called a Qualified Mobile Vendor License. It let them operate the trucks, but only as “delivery vehicles” for two stores. The license also required they have a staffed office and were restricted to operate at certain spots around the city. The solicitousness of Suzhou officials wasn’t unique. All around China, local governments were inviting in foreign businesses, easing the cost of doing business with tax breaks, and giving them friendly government liaisons to help them navigate the labyrinthine bureaucracy.

Then you will learn how the ice cream empire fell apart, for reasons that will likely not be unfamiliar to most foreign companies that operate in China — taxes and thieving employees who then go out and illegally and even violently compete:

The first inclination Sparks got that things were changing was around 2012, when a local official called him into his office and accused Sparks of not paying enough in taxes.

“Immediately, I knew it was a shakedown,” he said. “This guy was an idiot. He was like, ‘There’s money, I need some.’”

Sparks declined the man’s offer and left, but says that meeting was his first experience with the corruption he’d often heard about in China. Soon after, two new drivers alerted Sparks to a longtime scam by his eight other drivers. They were quietly making extra soft-serve sales and pocketing the money for themselves. Because Mister Softee was a cash business, office workers would count drivers’ ice-cream cones at the start and end of their shifts to make sure they weren’t stealing. To circumvent that control, drivers bought their own cones. When Sparks started measuring the ice-cream mix instead, the drivers would buy extra cones and mix, too.

Eventually, he instituted random checks on drivers and fired several on the spot when they were caught with more mix in their trucks than they had at the start of the day. Soon after, his tires outside his apartment were slashed. Then a fired driver showed up at Mister Softee’s office and threatened to kill the workers there.

Things got more bizarre. In early 2013, just a few weeks after they were fired, Sparks’s former drivers resurfaced with their own unlicensed ice-cream trucks, with knockoff names including Baby Bear, Snow Princess, and Mr. Big. These drivers would park along Mister Softee trucks’ routes to poach customers. Plus, they didn’t have the special city license, which allowed them to operate without having to open storefronts or an office, and they could sell wherever they wanted.

Conway was too far away to help out as problems started cascading. Cai, meanwhile, had moved to the suburbs about an hour away and was starting another printed circuit board business, so had no time to lend a hand.

*   *   *   *

Perhaps the slashed tires and death threats were unique to Mister Softee, but local officials’ deciding to yank support was downright typical of the changing times.

For the record, nothing that happened to Mister Softee in Suzhou is “unique.”

The article then goes on to rightly note that foreign companies that bring technology or know-how that China hasn’t developed on its own are still very much welcome in China, but the others not so much. “One in four foreign businesses are scaling back in China or say they plan to, and most say they feel increasingly unwelcome, according to a 2018 survey from the American Chamber of Commerce in China.”

The article extensively quotes Anil Gupta, professor of University of Maryland’s Smith School of Business, “who’s been researching and writing about China for 25 years” and who has this to say:

Gupta added that blatant knockoff enterprises are so common in China that it’s almost a wonder Mister Softee’s easily replicated business wasn’t copied sooner. Plus, local officials and courts are more likely to back the local knockoffs to support Chinese businesses — to hell with the permits.

“With 99 percent confidence, I would say this was destined to happen,” Gupta said of Mister Softee’s fate. “I would say that God couldn’t even save this business.”

What or who exactly killed Mister Softee. China:

After receiving one-year permits for his trucks without fail from 2007 through 2012, Mister Softee’s permits were withheld without explanation and Sparks couldn’t reach government officials for months to clear up the issue. When Sparks finally heard back from government officials in mid-2013, they told him they would figure out a way to regulate the new trucks. Nearly a year later, with Sparks still operating without a new permit, officials proposed holding a lottery to dole out Suzhou permits to Sparks and the knockoff trucks. Around that time, police started ticketing Mister Softee trucks for parking illegally in spots they’d been working for years.

By 2015, it became clear the lottery would never take place and Sparks’s new round of investment crumbled.

“Part of it was a relief, to know it was over,” Sparks told me. “You feel, obviously, helpless.”

Over the next year, he wound down the business, paid his remaining staff and sold off the trucks so some others could spread the gospel of neighborhood soft-serve to nearby cities.

In early 2016 on a Friday, Mister Softee’s tumultuous foray into China quietly ended with Sparks, his lawyer, and accountant filing liquidation papers and figuring out who they still owed money to. Sparks had already sold off the office furniture to his ice-cream cone supplier.

Ignoring for a minute whether any deity could have saved Mister Softee, was there anything it could have done to survive China? Maybe. Were a company like Mister Softee come to me today, I would likely recommend that instead of going into business in China, it seek our a licensee in China for its name and its ice-cream know how and its trucks look and feel. Indeed, my law firm a few years ago did a licensing deal on behalf of a regional American ice cream that has worked out very well for the American company. I constantly find myself trying to steer clients away from what I call “theoretical massive profits” that can allegedly be realized by going into China as a WFOE or a Joint Venture in favor of a licensing or distributing deal. See Forming a China WFOE: Needed or Not. See also my Forbes Magazine on this: Want Your Product In China? Try Using A Local Distributor.

Welcome to China 2018 people.

What are you seeing out there?

UPDATE: Literally minutes after I wrote this I received an email from a China lawyer friend who said I should have talked about how Mister Softee could have prevented “at least some of its problems” by having made its employees sign non-compete agreements. I don’t think those would have worked because China’s courts generally will not enforce those against any but high level employees and I do not think ice cream truck operators would qualify as high level employees. See