China self driving cars As I outlined in my previous post, Self Driving Cars in China: The Roadmap and the Risks, the Chinese government is pushing hard for development of a Chinese based self driving car. In reviewing China’s proposed legislative framework and recent books from China, we can see how Chinese’s system offers unique advantages for developing fully autonomous vehicles.

China does not seem to have the atavistic fear of robots and AI common in the Western world. Recent surveys show that over 75% of Chinese car buyers have a favorable opinion of self driving vehicles, as opposed to only 50% in the U.S. More significant is that 60% of Chinese auto buyers believe developing self driving cars is a significant issue, as opposed to less than 20% in the U.S. and in Germany.

Fear of autonomous driving is not a factor in China. The issues in China are more direct. Is a self driving car available? Will it be available in a reasonable time frame? Will a self driving car work well? How much will it cost? Will the vehicle be owned by an individual or by a ride sharing entity or (in China) by some service owned or managed by the government? These are rational economic considerations, not gut level fear of robots and artificial intelligence.

A Chinese consumer may decide self driving cars are not an important issue because they rationally believe they will never happen. But they do not oppose self driving cars due to a fear of robot control. The Chinese are generally not in love with driving. Driving in China basically sucks, and if they can leave the driving to someone else, the Chinese are generally happy to do that. And if the someone else is a robot, they don’t care. The issue to the Chinese consumer is: how much will that robot cost? [Editor’s Note: Peter Hessler’s book, Country Driving: A Chinese Road Trip, makes for a great read on driving in China.]

The Chinese also do not generally make unreasonable requirements on the safety of a self driving car. In the U.S. and in Europe there is an unstated but very real demand that self driving cars must be perfect. Every accident involving a self driving car is head line news and endlessly reported online. At the same time the 40,000 U.S. deaths and the ~25,000 EU deaths per year from human controlled driving are taken as business as usual.

The Chinese regulators and public make no such unreasonable demands. One goal of the Chinese government is for self driving cars to reduce the current very high Chinese passenger vehicle accident rate (~260,000 people die on China’s roads a year). However, the goal is to reduce the accident rate by a reasonable percentage. No one in China demands self driving cars be accident free. It is assumed they will NOT be accident free. The issue in China is whether the rate of accidents will be at an acceptable level or not. In China, it is assumed that the accident rate will decrease due to autonomous vehicles, but no one expects that rate to be dramatically lower than the current rate. For that reason (and probably some others), accidents involving self driving cars simply are not news in China.

Finally, the Chinese are free of the Western (especially U.S.) need to assign blame for accidents involving self driving cars. U.S. legislation and discussion of self driving cars almost obsessively focuses on this issue. Who will pay if there is an accident? Will it be the software developer? The auto manufacturer? The vehicle owner? What if the accident is determined to have been caused by a flaw in the software? Or a flaw in the installation? Or a flaw in the smart transportation network? Or the result of hacking by a third party? Or by operator error? Or by circumstances beyond the control of any party? Or even something as relatively routine as failed brakes?

If you examine U.S. based discussions of self driving vehicles, you will see these issues are primary and this is certainly even more true among the lawyers. Self driving projects then focus on issues like the ethics of driving decisions, insurance coverage, liability and damage allocation. Though these are primary issues in the U.S., they hardly exist in China. I have 200 pages of Chinese government proposed rules and regulations for autonomous vehicles on my desk. I have five full length Chinese language textbooks on self-driving cars, all published in the last two years. The issue of liability and insurance is simply not discussed at all in these thousands of pages. It is a complete blank.

There are two reasons for this. First, the Chinese are generally far less concerned with assigning guilt than Westerners. In Chinese traditional morality, guilt is not the main focus of an enquiry of what to do when a person is harmed or injured. In China, the focus is on how the social equilibrium can be restored as quickly as possible. The damage is repaired and the parties move on. Guilt and the associated liability for guilt is usually not a fundamental issue. Second, the Chinese insurance system is a no fault system so there is no reason to assign guilt. Auto accidents do not give rise tot moral issues. The issues arising from auto accidents in China are usually clear: what was the damage and what sort of payment is required to restore the parties to their original situation. Lawyers are virtually never involved, the award is limited to economic compensation and there is no high value award for non-economic matters like pain and suffering.

From the U.S./Western side, the fear of robots, along with unreasonable safety demands and allocation of liability in a guilt based system create substantial barriers to developing self driving cars. In the U.S., these barriers are at least as significant as the considerable technical barriers. In China, these non-technical barriers do not exist. It’s not that they are reduced; they don’t exist at all.

China can therefore focus on the technical issues. It is the technical issues that will drive the development of the vehicle of the future. So thought Chinese companies are currently behind the West on the technical side, they can move forward free from so many of the non-technical barriers that will both slow down and increase the costs of autonomous vehicle development in the West. This means China will reign as the primary testing ground for new technical solutions in the self driving car field. So even if China is not the place where the technology is developed, China will be the place where the technology is applied in real world applications. This is already happening in the electric vehicle market and this same trend will continue in the self driving car market.

Autonomous VehiclesDevelopment of the self driving car is the centerpiece of the Chinese government’s plan to redesign its manufacturing and technology sector. The Chinese have coined the term Intelligent and Connected Vehicles (ICV) (智能网联汽车)as their own technical term for describing the China version of what is an international race towards a difficult technical goal. The ICV is an ideal goal for China because it combines elements of all three of its current key technology programs: Made in China 2025, Internet+ and the Artificial Intelligence Strategic Plan.

As is typical of the Chinese system, the central government seeks to place itself on the top of the system, providing guidance and control from the top down. In furtherance of this goal, the PRC Ministry of Industry and Information Technology together with a number of related PRC agencies just issued a comprehensive set of national guidelines (建设指南) to provide the framework for development of ICVs in China.

The full set of guidelines is as follows:

(i) the National Guidelines for Developing the Standards System of the Telematics Industry (Overall Requirements) (国家车联网产业标准体系建设指南 (总体要求)). (June 2018)

(ii) National Guidelines for Developing the Standards System of the Telematics Industry (Intelligent and Connected Vehicles) (国家车联网产业标准体系建设指南 (智能网联汽车) (December 27, 2017)

(iii) the National Guidelines for Developing the Standards System of the Telematics Industry (Information Communication) (国家车联网产业标准体系建设指南 (信息通信) (June 2018).

(iv) the National Guidelines for Developing the Standards System of the Telematics Industry (Electronic Products and Services) (国家车联网产业标准体 系建设指南 (电子产品和服务) (June 2018).

Though the Guidelines are detailed and complete, these are only guidelines. That is, this is a standard to be followed for the drafting of binding regulations and statutes. The Guidelines merely set out the path to be followed. The real work remains to be done.

To date, the most important regulation with substantive impact is the Intelligent and Connected Vehicle Test Management Practices (智能网联汽车测试管理规范) issued on April 12, 2018. Under this regulation, individual Chinese cities are permitted to develop standards that allow for on the road testing of autonomous driving vehicles on public roads. In response to this new regulation, Chinese cities that seek to host the development of ICVs are working with the players to host testing in their own city. The typical regional divisions that characterize Chinese technology development are already taking form:

a. Beijing has set up a licensing program for Baidu.

b. Shanghai has set a licensing program for Ali Baba.

c. Shenzhen has set up a licensing program for Tencent.

Each city is seeking to establish its own regional champion in this new area. To avoid being left behind, other Chinese cities are joining in to create their own ICV on road testing programs. For example, the city of Tianjin recently announced its own ICV testing program in collaboration with the Tianjin Intelligent Connected Vehicle Industry Research Institute. It is expected that other Chinese cities will follow suit, with all of them seeking to create a regional (not national) ICV champion.

This movement towards regional rather than national ICV champions is of course contrary to the MIIT goal. But the overall development of the Chinese vehicle market shows that regional rather than national development is the dominant trend. There is little prospect that the Beijing authorities will be able to do anything to stand in the way of these regional developments. Note that this move to city/regional based ICV fiefdoms is dramatically different from the experience in the United States. California recently opened its roads to self-driving car testing. In response, over 50 different manufacturers have chosen to conduct tests on California roads. Consistent with general U.S. policy, California makes no attempt to favor one company over the other. The market will choose the winner. The Chinese system is developing in exactly the opposite direction, where regional governments are picking their winner in advance. Developments over the next decade will show which system works best.

This then leads to my central theme in considering this issue. In the development of the ICV, technology is everything. The Chinese central and regional governments have plenty of money for developing this program. But that money will be used in classic Chinese fashion. It will be used to purchase land and to build factories. That is, the money will be used for hard infrastructure.

But the question for China is what will those factories actually do? Without the most advanced technology, the factories will do nothing more than build the sort of low standard electric vehicles that already clutter the roads of China’s second tier cities. For the second tier cities like Tianjin, the technology issue is even more acute because the players in Beijing/Shanghai/Shenzhen are not planning to share their technology. In this project, it is every region for itself. So each regional player is faced with a existential issue: after the factories are built, from where will the ICV technology come?

The search for technology will be intense. A huge company like AliBaba can perhaps develop the technology on its own. But that only works for the Shanghai fiefdom. What about everyone else? In response, Chinese regional governments, research centers and production companies will be scouring the world for the latest in ICV technology. Since China currently appears to be the major market for electric and ICV vehicles, foreign companies will need to decide whether or not they want to work in China. For those companies that decide to work in China, the real issue will come down to the issue we continuously raise on this blog. Will you retain control over the technology or will you give it away? Will you get paid for what you give away, or will you wrap it up as a gift?

This growing market for ICV technology is an opportunity for foreign companies. The demand will increase over time, making the market for the transfer of ICV technology to China a long term trend. The question for foreign companies is whether China is a market where a profit can be made or is it just a trap leading to bankruptcy?

Though U.S. companies continue to complain about IP theft and forced transfer of technology to Chinese companies, there are ways to avoid presenting your technology to the Chinese side as a gift. But avoiding this result requires two things. First, you have to accept that if you refuse to make the gift, the Chinese side may walk away and you will then be excluded from that market. Second, you have to do the work required to provide yourself with protection. That means entering into tough, enforceable contracts and making the required patentcopyright and trademark registrations in China. If greed blinds your eyes to the risk, then you will not do either and the result will be predictable.

China NNN attorneyBy a wide margin, the most popular China contract my law firm writes is the China NNN Agreement. These are basic and important agreements no matter what your industry. We write these to protect against disclosure, competition, and circumvention. For more on what goes into our China NNN Agreements, check out our most read post, imaginatively entitled China NNN Agreements.

Unfortunately, not everyone uses my law firm’s China lawyers for their NNN Agreements and I say this for reasons beyond our not capturing the fees for those. I say this because our China attorneys receive a steady stream of emails from Western companies that want to retain us to sue on their existing NDA or NNN Agreement and after we review those agreements, we decline to take their case because their agreements are just not good enough. In fact, our firm has never taken on a breach of an NDA or breach of an NNN because we have yet to see such an agreement written by someone else that was strong enough to warrant litigation and because nobody has ever sought to sue on any of those we wrote.

Note. I am not saying that no other law firm can write a proper NNN Agreement for China. I am not saying that at all. I am merely saying — not surprisingly — that in situations where a Chinese company has signed an NDA or an NNN Agreement and then someone wants to sue on it, we have not liked the agreement on which they want to sue. Get it?

What then is so wrong with the NDAs and the NNNs my law firm sees and does not like? All sorts of things. The most common problem is that the agreement was not written for China at all. It is just a Western-style NDA used either as-is or cobbled together to try to look like it is for China. For why this does not work, check out Why Your NDA is WORSE Than Nothing for China. Probably the second most common problem we see is the situation where the Western company has an NNN that is 98 percent good, but then has a bad provision through which its Chinese counter-party can drive a truck. In these situations, I ask the Western company how the horrible provision came about and invariably their response is that the Chinese company would not sign the NNN Agreement without it and nobody told them how bad it would be for them to put that provision into the NNN Agreement.

WARNING. There are all sorts of ways a Chinese company can quickly and efficiently eviscerate a perfectly fine NNN Agreement with what can appear to be a minor change. For this reason alone, it is always a bad idea to get an NNN Agreement from your lawyer and then not go back to him or her with any proposed changes. When any of my firm’s lawyers draft NNN Agreements we make very clear that we see our role as handling the NNN transaction from beginning to end. See e.g., China NNN Agreements: How to Get Them Properly Signed and Executed.

I thought of all of the above recently when communicating with one of the best and most experienced attorneys I know. We were discussing “the old days” in China legal and how different they were and then we started talking about how in so many ways little as changed. On that front, this lawyer wrote me the following regarding NNN Agreements and IP theft [stripped of any identifiers and cleaned up substantially]:

Back in the 90’s I worked on a deal with a Chinese company that was entering the cellular phone business. The other side was ___________[Company X] from the United States. Company X insisted on a well-crafted, highly effective NNN Agreement. The Chinese side refused to sign this though, so Company X went home and said it would not come back until the agreement was executed. I asked the Chinese side why it would not sign the agreement. They said: “We won’t sign because we are doing this project to acquire the technology for ourselves. We are not going to disclose to someone else.” That is when I learned that non-use is more important than non-disclosure in these agreements. I told the Chinese side that if they didn’t sign Company X will not be back. The Chinese company eventually signed, but I also was sure to tell Company X that from the moment the paper document was signed, it would need to monitor what its Chinese counter-party was doing with its IP. Nothing really much has changed since those days except Chinese companies have become far more clever and they no longer  make it clear from the start what they are planning to do. But as you and I both know, that does not mean anything else about these deals and what is needed in these agreements has changed.

Yup. What are you seeing out there?

China manufacturing contractsOur China lawyers have of late been receiving more than the usual number of emails and phone calls from companies (mostly American and European) wanting to pursue litigation against their Chinese manufacturers for bad product. In these “bad product” cases — especially if it is with a formerly “good” manufacturer — the product problem frequently stems from a sloppy subcontractor used by the Chinese manufacturer with whom the Western company has been working. The Chinese manufacturer freely reveals it used a subcontractor and blames the bad quality on the subcontractor. In most instances, the Western company did not even know that anyone other than its Chinese manufacturer was working on its product.

Truth is most internationally savvy China manufacturers are incredibly busy these days and loath to turn down good work they subcontract like crazy. Sometimes the subcontracting is for one portion of a product, oftentimes a portion they themselves are not even capable of making. Other times though, they will subcontract out all of the manufacturing.

We have handled many cases for foreign companies that received bad product from their previously reliable suppliers and in well over half of these cases, the product quality problems stemmed from their Chinese supplier having subcontracted out all or at least a portion of the manufacturing. The Chinese supplier usually admits to having subcontracted the work and sometimes even remarks that the problems otherwise would never have occurred. The supplier admits legal responsibility for the quality control problem, but then usually proposes remedying it by giving a small discount on future orders until the damages from the bad product have been covered. The foreign company is usually in no mood to continue doing business with the offending supplier and wants only a monetary remedy. However, because the profit margins at most Chinese manufacturers are so low, they often cannot pay all the damages caused by the bad product and a standstill results that can only be resolved through litigation.

The best solution for this is to prevent it from happening in the first place and the way to do that is to choose the right supplier and use a good manufacturing contract. When our China lawyers draft manufacturing contracts we usually include a provision precluding the Chinese manufacturer from subcontracting out production without first securing written permission from our client. Almost without exception the Chinese manufacturers have agreed to this provision and (at least as far as we know) they have abided by it. The reason for this is simple: the manufacturer may have 20+ companies for whom it produces goods, but very few (if any) contractually forbid subcontracting. When the Chinese manufacturer is so busy as to require subcontracting, it makes sense for it to subcontract work for those foreign companies for whom it is NOT prohibited by contract from doing so. I analogize this to bike locks. Even the best bike lock cannot prevent all thefts, but its efficacy comes from the fact that bike thieves generally find it easier to steal a bike with a poor quality lock or none at all than one that is difficult to break.

For more on China manufacturing contracts, check out the following:

China design patentOur China IP lawyers have lately been seeing a steady increase in China design patent filings, as Western companies increasingly come to understand the need to be proactive in protecting their IP from China. We file most design patents to protect product designs, but some are filed for defensive purposes. The defensive design patents are filed not so much to protect the filer’s own design, but to prevent Chinese companies from securing and using China design patents to block Western companies from selling in China or even exporting from China.

When called on to file a China design patent, our China attorneys typically request the following information for the filing:

  • The name and passport number (if you are not a PRC citizen) or your national ID number (if you are a PRC citizen) of the person who designed the product for which you are seeking the China design patent. If you commissioned a design firm who actually designed the product, the name should be that of the person at the design firm.
  • The priority date, if relevant. You would only have a priority date if you filed for a design patent application for this design in a jurisdiction other than China in the past 6 months.
  • If you previously filed a design patent application in a jurisdiction other than China, please send us a copy of the filing documents.
  • A set of formal drawings for the design. Assuming you want the China design patent to cover all sides of you product, we need need an orthographic projection of all sides — usually this means six sides: top, bottom, left, right, front, back, plus a perspective graphic. The drawings cannot contain dotted or dashed lines, or shading to indicate perspective.
  • A brief (one-paragraph) description of the name and use of the product incorporating the design, and the essential features of the design.

Note that China design patents require absolute novelty. This means that if you have already disclosed or commercialized this product anywhere in the world, it is not eligible for design patent protection in China. That said, if you already filed for a design patent in a Paris Convention country (which includes almost every country in the world) you may be able to file for a design patent in China on a priority basis and claim the earlier-filed date as the effective filing date for your China application.

Once we collect the above information, we will review it and then set it up for a design patent filing in China. That’s pretty much it — there will be no substantive check by the China patent authorities for prior art or anything else. The only time the China patent office substantively reviews design patents are when they are challenged for validity.

For more on China design patents, check out the following:

 

China Manufacturing ContractsAs China and its laws change, the China lawyers at my firm must constantly adjust, usually just ever so slightly. This adjustment can include even how we draft our contracts for China. And oftentimes, with even small changes in how we draft our contracts, we make changes in the questions we ask to gather the information we need to draft a contract that suits both their situation and their goals.

The following is the initial email questionnaire our China manufacturing lawyers are currently using with companies looking to engage in OEM manufacturing in China. Our lawyers send this out and then review the responses, all as a prelude to drafting the  Manufacturing Agreement

 

 

The below is fairly comprehensive, but feel free to provide any additional information that you feel may be relevant. Please answer as much of the below as you can and to the extent any of our questions are irrelevant, please feel free to write N/A, but to the extent it might make sense for you to explain to us why something does not apply to you. Please do so. We will likely have followup questions depending on your responses to the below.

Note that the agreement we will be drafting for you will be intended for use within mainland China with manufacturers based in mainland China. It is not intended to be used with sourcing agents, nor is it intended for use in Hong Kong, Macau, Taiwan, or any other country or administrative region outside China.

1. Basic Information

  1. For each entity that will be executing the agreement, please supply the full legal name, address, phone number, fax number, and URL, as well as the name, title, and email address of the representative who will be signing on behalf of that entity. (In both Chinese and English, as relevant.)
  2. Please identify the state in which your company is incorporated.
  3. Will you be using this OEM agreement only with this specific manufacturer, or are you hoping to be able to reuse it with other manufacturers?
  4. Please provide a copy of your Chinese counter-party’s business license.
  5. To the extent multiple entities will be involved in this agreement on the Chinese side, please identify each of these entities and describe their corporate structure. For instance, many OEM contracts involve one Chinese company that owns a factory and performs all manufacturing and a second company (usually based in Hong Kong) that issues invoices and receives payment.

2. Design Basics

  1. Do you anticipate the Chinese side will be performing any design work or customization as part of the manufacturing process?
  2. If not, are you ordering “off the shelf” products the Chinese side already manufacturers?
  3. If so, have you already entered into a design services agreement? What arrangements have you made regarding ownership of the designs, payment for the designs, milestones, and ordering obligations?

3. Manufacturing Basics

  1. Please describe each product the Chinese side will be manufacturing. Do you anticipate these products will change over time?
  2. What sort of volume are you expecting? Will the volume change over time? Have you have agreed to order a minimum number of products? If so, please provide details.
  3. Do you wish to prohibit subcontracting? Are you aware of any third parties that will be involved in manufacturing, packaging, or shipping your product? This includes any entities that may be owned by or otherwise affiliated with the Chinese contract party.

4. Pricing

  1. Have you determined the prices for the products yet? If so, please include the relevant details.
  2. How will pricing and related terms be negotiated? On a purchase order basis? On an annual basis? Some other way?
  3. Have you negotiated the payment terms? For instance, will you pay by letter of credit? By installments? If by installments, what are the amounts/percentages of those installments, and when are they due?

5. Purchase Orders, Shipments, and Inspections

  1. Do you have an existing purchase order you intend to use for your product orders from these manufacturer(s)? If so, please provide us with a copy.
  2. After receiving a purchase order, how long does the manufacturer have to accept or reject it?
  3. If you submit a purchase order and it is not accepted by the Chinese side, what happens? In other words, is the Chinese side bound for some period to make a certain amount of product at a certain price or only obligated to make product for you after it accepts your purchase order?
  4. What have you negotiated regarding shipping terms? For instance, how long after acceptance of a purchase order will goods be shipped? Will you be using a freight forwarder? From and to which ports will the goods be shipped? Will the goods be shipped FOB or CIF or something else?
  5. What arrangements will be made for packaging prior to shipment?
  6. When your products are shipped from China, what brand names, logos, and/or slogans will appear on the products and packaging? Please distinguish if possible between words and graphic logos.
  7. Where do you anticipate selling your products? In particular, will you be selling them in China?
  8. If you are selling any product in China, what brand names, logos, and/or slogans will appear on the product and on its packaging?
  9. Will any product you manufacture in China have a Chinese name? Does your company have a Chinese name? If so, please provide them.
  10. What sort of arrangements have you made for inspection and quality control during the manufacturing and packaging process (i.e., pre-shipment)? Exactly what should be done with any defective product discovered during the manufacturing process?
  11. What sort of arrangements have you made for inspection and quality control upon receipt (i.e., post-shipment)? Exactly what should be done with any defective product discovered then?

6. IP and other concerns

  1. What are your main concerns in this deal? Are you concerned with ensuring high product quality? Receiving products within the agreed-upon time?  Protecting your intellectual property (i.e., ensuring the Chinese manufacturer does not sell your product behind your back and/or steal your designs)? Pricing?
  2. Do you have any trademark registrations in China or anywhere else in the world (pending or otherwise)? If yes, please list them.
  3. Do you have any patent or copyright registrations in China or anywhere else in the world (pending or otherwise)? If yes, please lis them.
  4. Do you have a list of customers, suppliers, or other third parties you want to prevent the Chinese party from contacting

7. Tooling and Molds

  1. Will the Chinese manufacturer be using any tooling or custom molds to make your products?
  2. If so, does the manufacturer already have all of the tooling in question? Which party owns the tooling?

8. Warranty

  1. What sort of warranty terms have you negotiated or do you expect?

9. Term

  1. Have you determined the length of time this deal will be in place?

10. Other issues

  1. Has the Chinese manufacturer already signed any sort of term sheet, memorandum of understanding, letter of intent, or other document, even if only in English? If so, please provide this document.
  2. Have you previously purchased any products from this manufacturer? If so, please provide an example of the purchase order used.
  3. Are there any unresolved issues involving any previous manufacturers? For instance: have you gotten all of the tooling back from any previous factories? Are there any outstanding invoices or payments due?

China trademark law firmNobody disputes that Chinese factories that make OEM products for American and European companies are increasingly looking to make their own products for selling directly to consumers. Nobody disputes that online marketplaces have made this much easier.

And yet….

And yet, without fail and probably at least twice a week, we get emails from stunned companies reporting to us that they have just learned that their Chinese factory has registered “my trademark” or “my patent” in China and is selling our product for 25-75% less. We have gotten more such emails/calls in the last year from companies whose China factories are now directly competing with them than in the three years prior combined. And yet we also still get emails from companies that tell us that they “like” or “trust” their China supplier so much that it does not even make sense for them to spend money trying to stop this company from competing with them or that even asking their trusted China partner to sign anything would be viewed as an insult.

WRONG.

When companies tell me no contract is necessary I usually simply wish them the best of luck. When companies tell me that they are worried about asking their Chinese company to sign anything, I tell them that Chinese manufacturers expect to sign contracts these days and they view foreign companies that do not require them to do so as suckers. But what I want to tell the companies that are planning to rely on their good and trusted relationship with their Chinese suppliers is that pretty much all business relationships start with trust because who goes into a relationship with someone they either hate or know to be dishonest? You want a contract to memorialize your good relationship. You want a contract when you are in agreement and therefore have something to put on paper in the form of a contract. Contracts cannot be written if the two sides cannot agree.

With online selling having become so easy for Chinese factories, your product has never been more at risk for competition by the very same factory to whom you provide your molds and your know-how and your technology. Chinese factories know this and many are agreeing to manufacture products at money-losing prices simply to acquire the knowledge that will allow them to sell those same products directly themselves.

Some of these Chinese factories will not create duplicates of your products for their foreign buyers — be they your competitors or your customers. They instead take what they have learned from manufacturing for you and use that information to compete directly with you. Since you will essentially be educating your Chinese manufacturer on how to compete with you, you need contracts and IP registrations that will at least limit what it can do when it does.

Chinese factories are becoming increasingly confident about selling their own products online and therefore more willing to risk losing their foreign OEM product customers to do so. Add to this that nearly all of the online retail platforms are focusing on helping Chinese manufacturers sell directly and you should be able to see exactly where all of this is leading.

What though can you do to stop this? The better question is what can you do to slow down and reduce this sort of competition? I suggest you read the following:

Despite the need to have a contract (or multiple contracts) with your Chinese supplier and despite the need to always be alert to what your Chinese supplier is doing with your product and in your product marketplace, there is still room for a good relationship and having such a relationship is important. Think of the contract as a way to bolster your good relationship with your supplier by reducing the issues on which there will be disagreements.

Trust yet verify.

What are you seeing out there?

China Manufacturing Lawyers. China IP Lawyers

I wrote a four-part series on product development in China, entitled, Hardware Co-Development in China: Do it Right — Part 1 is here, Part 2 here, Part 3 here and Part 4 here. This series helped explain why developing products in China can be so complex and why it is so important to protect your intellectual property during the product development process. In response to those posts a number of people have asked our China lawyers how to structure product development relationships with Chinese companies so the foreign company actually ends up with the rights to the product that gets developed. This post addresses that issue.

The key is to focus on manufacturing rights, rather than on intellectual property rights, especially when the PRC or Taiwan factory presents the foreign product developer with an already prepared manufacturing agreement. Lawyers all over the world have become masters at writing complex and sophisticated intellectual property provisions for product development and manufacturing agreements. Because these IP provisions are written to cover every possible situation, they are usually written at such a high level of abstraction they often have little to no real meaning on the ground in Asia.

Our solution at this point is not to further refine or revise the already highly refined IP language. Instead, we recommend focusing instead on the practical issue of manufacturing rights. At the end of the development process the Chinese factory and its foreign customer (our client) will be looking at a set of prototypes and the sole issue for the foreign party at that point is usually what can I do with those prototypes? If this question is not clearly resolved in an enforceable contract at the start of the development process, the answer will usually be that the foreign party cannot do anything with the prototypes beyond what the Chinese factory allows it to do. For what is required for a contract to be enforceable, check out China Contracts that Work.

To avoid this result, at the inception of the development process the foreign party should secure a written and enforceable contract that includes the following:

  • A clear statement of what will be done, when and by whom. This should include a clear description of the product to be designed and the work to be performed.
  • A clear statement of the costs, the allocation of costs, and the payment dates for the costs. It is important that your contract be written to provide a clear understanding of what will be provided by the Chinese manufacturer in return for the payments. This provision should address molds, tooling, software, design, and a working model.
  • A clear statement that if the design project fails, all the tangible and intangible materials developed during the project will be transferred to the foreign customer with nothing retained by the Chinese factory or designer.
  • A provision stating that if the design project succeeds and prototypes are developed the foreign customer shall have the right to manufacture the product in any factory anywhere in the world. The foreign party should be free to determine what factory will manufacture the prototyped product. Normally, this will mean manufacturing it in the factory of the co-developer, but what if that factory cannot make the product for a satisfactory price, or in satisfactory quantities, or with satisfactory delivery dates or quality? What if the Chinese factory insists on raising its prices six months later? For you to be able to maintain control over your product, you must have the right to move some or all of the manufacturing of your product to the facility of your choice, for any reason at all.

This issue of the right to manufacture should be clearly understood by both sides before the parties start discussing the more abstract issues of intellectual property rights. Every factory owner and every foreign party understands the issue of manufacturing rights and if you negotiate this early on, the real situation will be revealed in a way both parties understand. When the parties reach clear agreement on manufacturing rights, the intellectual property provisions become relatively easy for our China IP lawyers to draft.

If you wait to seek agreement on manufacturing rights with your China factory until product development has concluded you will have relinquished your leverage. If you wait until your Chinese factory completes the prototype, it can deny that you have any manufacturing rights and it can raise its manufacturing prices with near impunity. You need a China appropriate contract making clear you (not your Chinese factory) own the manufacturing rights because without this your Chinese manufacturer will probably be able to stop your product from being made by any other factories in China or from leaving China if it is.

When beginning the product development process in China it will often make sense for you to skip abstract discussions of intellectual property rights and just focus on the key practical issue both parties can understand: when the prototypes are finished, what can you do with those prototypes? It pays to discuss and resolve this issue early on with your Chinese manufacturer. For what should go into a China product development contract, check out China Product Development Agreements.

China sourcing contractsOne of the first things our China lawyers do when working with a company having products made in China is figure out the contracts and IP registrations that will ensure our client’s intellectual property and other rights will be protected as against its Chinese manufacturer and the rest of the world. In doing so, our China attorneys typically choose from the following manufacturing related agreements and IP registrations:

1. NNN Agreement. NNN Agreements are basic agreements that protect the confidentiality of your products and prevent your Chinese manufacturer from competing with you or circumventing you by going directly to your customers (non-disclosure, non-compete and non-circumvent. Their highest and best use is usually before you chose your specific Chinese manufacturer. Oftentimes an NNN Agreement is not needed because it makes better sense to put the substantive provisions from the NNN Agreement into a Product Manufacturing Agreement, described below. NNN Agreements normally are relatively simple agreements but for one to work with China it must be done correctly and using an off-the-shelf American or European NDA Agreements will not work for China. See Why Your NDA is WORSE Than Nothing for China

2. Mold/Tooling Protection Agreement. This agreement makes clear that the molds/tooling you are having made for you will actually belong to you and cannot be used to make products for anyone but you. Without such an agreement, when you seek to move your production to a new manufacturer, your old manufacturer will very likely keep your molds/tooling. Without this agreement there is also a good chance your old (or even your present) manufacturer will use “your” molds/tooling to make “your” products and compete with you. Just as is true with China NNN Agreements, it often makes sense to skip this agreement and put its substantive provisions into the Product Manufacturing Agreement. For more on these agreements, check out Manufacturing in China: Control Your Molds (Part 1), Manufacturing in China: Control Your Molds (Part 2) and Manufacturing in China: Control Your Molds (Part 3).

3. Product Ownership Agreement. This agreement makes clear the product you are co-developing with your Chinese manufacturer or having made by your Chinese manufacturer belongs to you. This makes sure you have something in writing and enforceable in both China and in any other country in which your product is going to be sold. Without this agreement, your Chinese manufacturer may be able to claim ownership to the IP rights in “your” product and register a patent in “your” product in China and in other countries. See China and The Internet of Things and How to Destroy Your Own Company. This agreement is rarely needed because a Product Development Agreement or a Product Manufacturing Agreement usually can cover the product ownership issues.

4. Product Development Agreement. This complicated agreement should set out the terms of your product development relationship with your Chinese manufacturer, In particular, it should specify who will own what of the finished product and who will pay for what to develop the finished product. These agreement should make clear what you will be paying in product development costs and it should set out the various milestones your Chinese product manufacturer must meet to get paid. At minimum it should address (1) the product to be developed, (2) the technology the foreign company and the Chinese manufacturer will contribute to develop the product, (3) who will provide the product specifications and in what form, and (4) who will own the IP rights to the final product.

5. China Manufacturing Agreement. This agreement is often called a Product Sourcing Agreement or OEM Agreement. These complicated agreements should clarify pretty much everything between you and your Chinese manufacturer and unless you are spending small amounts on your product purchases, you need a China Manufacturing Agreement. Among other things, this agreement usually should — at minimum — address the following:

Quality

Timeliness

IP ownership

Mold and/or Tooling ownership

Non-compete, non-circumvention, non disclosure See NNN Agreements above

Sub-supplier/sub-contractors

Liquidated damages for breaches

6. China Trademarks. If you are having your product made in China you should secure a trademark for whatever brand name (and probably whatever logo) you are putting on your product or its packaging. If you don’t do this, someone else probably will and then they will use their trademark to stop your product from leaving China. You also should secure trademarks in the countries in which you will be selling your product because trademarks do NOT cross borders. Getting a China trademark is nearly always essential.  See China: Do Just ONE Thing: Register Your Trademarks.

7. China Patents. If your product is innovative or distinctive in its function or its design you should consider securing a China invention or design patent. These patents can be valuable/necessary to protect your product against copying and to prevent someone else from registering a patent on your product in China and then using that patent to stop you from manufacturing your product in China or from leaving China’s ports. See China: Do Just ONE Thing: Register Your Trademarks AND Your Design Patents.

The thing we as lawyers always need to focus on is maximizing value/protection for our clients will minimizing costs. This involves choosing the right agreement(s) and the right registration(s) at the right time(s) and doing everything correctly. See China Contracts: Make Them Enforceable Or Don’t Bother and China OEM Agreements. Why Ours Are In Chinese. Flat Out.

Easy-peasy, right?

China IP lawyersChina (Shenzhen mostly) is the primary destination for manufacturing of small electronic consumer products. And since Internet of Things (IoT) products are red hot, this means our China lawyers get a steady stream of China IoT legal matters.

The big issue we most often see is this: the IoT product has now reached the mass production stage and is being produced in large quantities. Now that it has a commercial product, the U.S. or European (usually) buyer now seeks financing for its start-up company. The financier (be it angel, VC, private equity, or even someone’s father-in-law) then asks who owns the intellectual property in the product? With the rise of the Internet of Things (IoT), this question is often difficult to answer definitively.

How did we get to this point where the IP rights of a product are so often vague? The process has worked its way through three general stages:

Stage One. In the good old days (roughly 1981 to 1995), the situation was simple. There were two possibilities. In the first, the Chinese manufacturer made a standard consumer product. The foreign buyer purchased that existing product and perhaps required the Chinese manufacturer take the extra step of placing the buyer’s own trademark/logo on the product. In that setting, ownership of the intellectual property was clear: the Chinese manufacturer owned the product design and the foreign buyer owned its trademark/logo. In the second, the product was a long standing, well developed product of the foreign buyer. The foreign buyer brought the completed product to the Chinese manufacturer and contracted with the Chinese manufacturer to make a copy. In that setting, ownership of the intellectual property was clear: the foreign buyer owned all the intellectual property and the Chinese manufacturer owned nothing.

The simplicity of this sort of relationship encouraged the somewhat lazy practice of documenting the entire manufacturing relationship with purchase orders. NNN agreements, product development agreements and OEM agreements were seldom used, since IP ownership was clear and the price and delivery terms were resolved via the purchase orders. This approach would often lead to product defects, but that is for another post.

Stage Two. In stage two (roughly 1995 to 2015), a new form of manufacturer-buyer relationship developed. Foreign buyers began coming to China with no completed project in mind; they instead would come with a product idea or proposal. The foreign buyer would then work with the manufacturer to co-develop a product. In some cases the Chinese manufacturer would simply take a completed prototype and commercialize that prototype for mass production. In these cases, the foreign buyer arrived with little more than a basic idea and the two sides worked to co-develop the product. See China Product Development Agreements, for pretty much everything you need to know about China product development agreements.

The Chinese manufacturer usually would perform the product development work at its own expense, with the implied agreement being that it would be the exclusive manufacturer of the product. This co-development process typically used the same lazy “purchase order only” approach from stage one. This approach then led to the many issues we see today that make answering the “who owns what IP” question so difficult. To do the co-development process properly, the parties must define their relationship with three agreements: 1) an NNN Agreement, 2) a Product Development Agreement and 3) an OEM Agreement.

When these agreements do not exist, a standard set of issues arises: Who owns the product design? Who owns the molds and other tooling? Who owns the manufacturing know-how and similar trade secrets? If the buyer decides has the product made by a different Chinese factory, what compensation is owed to the Chinese manufacturer that co-developed the product? What are the  Chinese manufacturer’s obligations to comply with the foreign buyer’s price and quantity requirements? If the Chinese manufacturer terminates its relationship with the foreign buyer and manufacturers the product under its own trademark/logo, is this a violation of any agreement between the parties? Absent clear written agreements, none of these questions have clear answers. In these unclear situations, the Chinese factory will nearly always be in a much stronger position than the foreign buyer and the Chinese factory will typically prevail in any IP dispute.

Stage Three. In stage three (2015 to today), we arrive at the IoT era. In designing, developing and manufacturing consumer products for the IoT market, the already unclear and problem-filled relationships of the stage two era are now magnified. In the IoT era a whole new set of issues has arisen. In the stage two era, there was at least the simplicity of two entities designing and/or manufacturing a single product. In the IoT era, the situation is considerably more complex. In most of the IoT projects we have done, the development process has expanded to include the following:

1. Product “concept” from the foreign (usually United States or European) buyer.

2. Product external design, from an international design firm.

3. Internal design and function, owned by:

a. The foreign buyer;

b. The Chinese manufacturer;

c. The provider of sensors and other components required to connect the IoT product to an outside network.

4. Design of the IoT product “app” (usually for smart phones). This involves two completely separate sets of software: the communication sending software residing on the IoT product and the communication receiving software residing in the application. In the same manner as the internal design, these software components may be written/designed by multiple parties: the foreign buyer, the Chinese manufacturer and (quite often) third party software design firms.

What happens then when the product is complete, and manufacturing is ready to start and the foreign buyer starts to seek funding: The funding source almost invariably will ask who owns the IoT product? Who owns its underlying IP? What our China lawyers have far too often found when we ask the foreign buyers these questions is that they usually don’t really know.

This “we don’t know” response does not sit well with potential sources of serious financing. Even worse, when the foreign buyer is pushed to answer the question, it becomes clear that it is not clear who owns the new product. Far too often the only ownership issue that is clear is that the one entity that the foreign buyer is the one entity that does NOT own the rights to the product. Even worse, it is usually not possible to fix the situation by this point.

Bottom Line: As manufacturing in China and the IP issues attendant with that become more complex, it becomes even more important that you have clear written agreements that answer the obvious IP questions in advance. It does not make sense for you to devote your time and your energy and your money developing an IoT product for someone else to own.

For more on the issues involving China and the Internet of Things, check out the following: