China lawyers IP
Don’t gift your IP to China

When working on complex contract manufacturing agreements, most of our clients tell us their main goal is to protect their intellectual property. This is particularly true for designers of start-up products where much of of their IP consists of trade secrets and know-how that require a formal agreement with the manufacturer. However, as we work with the client, we frequently learn that the client has already gifted their IP to the Chinese manufacturer. Making a gift to your family and friend is a nice gesture. But no foreign designer of a product intends to make a gift to a Chinese factory owner. The gift is unintended, and the consequences are virtually never good.

Here is what usually happens. We begin drafting the contract manufacturing agreement. In our standard set of questions, we ask about the status of molds. The client then reports something like the following: “We have already provided the designs for our molds to our  Chinese manufacturer and the manufacturer has already fabricated the molds. The current issue is focused on payment for the molds.”

We then ask our client about its plans for commercializing their product idea and fabricating production prototypes. The client then reports: “We have been working with the manufacturer for months to fabricate a production prototype. The manufacturer agreed to engage its own engineers and designers for this process. We now have two prototypes and we are ready to begin production. The only issue now is how to pay for the work on the prototypes.”

In both cases, we ask the following sorts of questions:

  • What form of documentation did you use in connection with providing your confidential design information to the manufacturer?
  • What did you do to formally protect your IP?
  • What did you do to make clear you own the entire design in the molds?
  • What did you do to make sure you own all of the design work that went into the design and manufacture of the prototype?

Far too often, our client answers with something like this: “The only documentation we have in place is a simple purchase order  for the molds. There is no documentation at all relating to the prototype. We were told that using purchase orders at this stage is standard so we did not think about it.”

The above scenario with slight variations is almost standard for start-up companies making their first foray into China’s manufacturing market. We then have to tell our client something like the following: “You indicated your primary goal is to protect your intellectual property. But, by providing your design data to your Chinese manufacturer with no documentation and by allowing the Chinese side to design and fabricate molds and prototypes, you have effectively given your IP to the Chinese manufacturer. The issue for us now is to determine whether or not the manufacturer will agree to return this gift. Sometimes they will, usually they will not.

In this setting, it is possible for the Chinese manufacturer to appropriate the product and to begin producing the product in its own name. When the foreign designer protests, the Chinese manufacturer points out that it did the actual design and fabrication work for the molds and it also did all the design and fabrication work for the product prototype. And since it did all of this work, it owns the design. And here’s the thing: legally, so long as the Chinese manufacturer does not infringe on the registered trademark of the foreign party, it is generally free to manufacture the product and sell it wherever it wants.

Absent formal written agreements, litigation in most countries to determine who owns what in terms of the product is fact intensive with the eventual outcome usually unclear. The lack of clarity simple kills off the chances for most start ups to market its product effectively. So when this situation happens to a foreign start-up, it can mean commercial death. The Chinese side is counting on this. A dead company cannot support litigation required to resolve the issue. Even for well established companies, this situation can cause substantial economic damage, since the effective marketing of a new product is made so difficult.

In most cases, however, the Chinese manufacturer is not interested in selling the product under its own name; what it usually wants is to create a situation where the foreign buyer does not have the option to have its product manufactured by any other manufacturer. The Chinese manufacturer wants to ensure it is the sole entity with the right to manufacture the product. By getting this it essentially has the pricing power of a monopoly on manufacturing the product.

Here is how it works out on the ground. At some point, the foreign buyer decides it wants to change to another manufacturer because a) the manufacturer substantially raises its price, b) the product is consistently defective, or c) the manufacturer cannot keep up with the required production volume. The foreign company wanting to go to a new manufacturer requests its existing manufacturer transfer its molds and the product prototype to the new factory.

The manufacturer refuses to comply with this request. The manufacturer says: “we own the design of the molds and we own the design of the product prototype. We will agree not to manufacture the product for ourselves or for any third party. On the other hand, you are not free to take the molds and prototypes to any other factory. You can only manufacture the product if you use our manufacturing services to do so. In legal terms, the Chinese manufacturer is saying it will provide an exclusive license to the foreign company to manufacture a product for which the design is owned by the Chinese side.

If the foreign buyer insists that it wants to move its manufacturing elsewhere, some Chinese manufacturers will say that the foreign buyer is free to start from scratch with a new factory. Other Chinese manufacturers will take a harder line and state that manufacturing the product in any other facility is an infringement on its IP and it will take action to prevent that infringement. In the last couple of years, more and more Chinese manufacturers are doing whatever they can (usually via cease and desist letters and litigation) to make manufacturing by others impossible. Either way, if the product is complex in any way, the foreign buyer is in a situation where it is required to work with the original Chinese manufacturer. This then means the foreign buyer can take no practical action to deal with the various issues that caused them to want to move to a new manufacturer. In particular, the foreign buyer is helpless in dealing with a price increase.

Many clients are skeptical when we explain this situation to them. They simply cannot believe they gifted their most valuable asset to another company. Some tell us that their Chinese manufacturer is an honest and upright company that would never act in the ways set out above. Others say that since they paid for the work, it must be the case that the Chinese factory will recognize that the foreign side owns the design and is free to take the molds and prototypes to any other factory for manufacturing.

In our experience, the situation is quite different. In the past decade, in every case on which any of our China lawyers have worked, the Chinese factory took one of the positions outlined above and refused to back down. In other words, once you have gifted your IP, you should not expect the Chinese side will graciously return the gift. Once the gift has been made, the Chinese side will keep the gift and make use of the gift to its advantage.

What does the manager of the start-up tell its investors after having given away the IP at the core of its product and its business? Our China attorneys have had to help with these sort of conversations and we probably hate these conversations almost as much as the managers themselves.

So in an effort to make life easier for product manufacturing start-ups we fervently propose you EARLY ON make use of the following agreements when working with Chinese manufacturers:

These agreements should be executed in advance of any transfer of design information to the Chinese manufacturer. Purchase orders come at the end of the process, not at the beginning. Unless you want to gift your IP to your Chinese manufacturer without realizing it. Oh, and while you are at it, you should seek to register your trademarks in China and look into registering your design patents (and maybe other patents) in China as well.

China lawyersPractically every month one of my firm’s China lawyers will get an email or a phone call from someone who bought an expensive chemical from a Chinese company only to receive baking powder. One very savvy chemical industry client once told me that “more than 95% of the China companies selling chemicals online are fraudsters and many of these companies are not really even in China.” I have no doubt that this person was exagerating for effect, but another such person I know insists that the percentage does scrape 50 percent. But all this is old news and if you want to read an in-depth post we did on one particular such scam go to Anatomy Of A China Scam. Just The Facts.

What is also old news is how there is a long history of Chinese fishing companies (much fewer than 95%, that I know) sending over large amounts of spoiled fish and then claiming the fish went bad en route due to no fault of theirs.

But here’s the “new news”: the sending of “junk” instead of real product has spread to pretty much every industry in China and ordering your products from reputable online sites provides little to no protection. Our China attorneys have consistently found that ordering products from a Chinese manufacturer listed on a site that claims to screen its vendors or claims to provide you with recourse provides little to no added protection.

The below email (modified so as not to reveal anyone) is 100% par for this new course:

Hello, Not sure what to do here with my situation, I’m very flustered here. I worked with a reputable company in China to manufacture window awnings [I made this up] on which I have a U.S. patent pending and also have trademarked.  I received samples from them and all was good. I placed an order for 5000 pieces and they are of the wrong material, warped and the sections that are supposed to open freely do not operate correctly because of the wrong material. I spent hundreds of thousands on this order and now they will not get back to me. They told me they were going to rework the products because they knew there was an issue. Now I have all this product that is useless that I cannot sell and I am paying storage on all of it because I am hoping still to be able to return it. I did use ______________ to find them and but it seems they cannot do much to help me. I’m out so much money and yet still trying to get a new product to market but that is proving really difficult because I have been hurt so badly financially. Can you help.

My response to these sort of emails is usually very short and it consists of my explaining that the odds are overwhelming that we cannot help them and that they should think long and hard before throwing good money after bad. I then mention something along the lines of how they should not order from China again without doing a lot of things differently than the first time.

But here I can say a more about why this sort of thing happens and what you can do to prevent it from happening to you.

  • These things happen because the buyer does not conduct due diligence on the seller. It is that simple. I swear, half the time when I get an email like the above and I spend 2 minutes searching out the Chinese company on the internet I find multiple instances of fraud committed by the same Chinese company.
  • Almost always the Chinese company that committed the fraud does not really exist. In other words, it is not registered anywhere in China or if it is registered as a real company in China it is registered for something like plumbing repairs, not for manufacturing window awnings.
  • These fraudsters are smart and there are good reasons why they spend the money to send you something instead of nothing at all and why they at first claim they will remedy the problems and why they so often continue to make that claim. The reasons are usually two-fold. One, sending even really bad product is less likely to lead to criminal charges than sending no product at all. If the police come by the Chinese fraudster can say, “I sent them the product they ordered. It’s not my fault those Americans/Europeans/Australians are so picky.” Two, by stalling they can keep their scam alive for much longer. They’ve paid for advertising and for a website and they’ve even bought the really bad product (be it spoiled fish, baking powder or bottom of the line window awnings) and they want to maximize these expenditures
  • Be careful when establishing business relationships with a new company. Do as much due diligence as you can. Send people you trust to do a site investigation of the manufacturing site.  Do a site inspection on goods before payment. Make sure the company exists and is legally able to conduct the business for which you will be paying it.
  • Use a contract that actually works for China and that sets forth clearly what you are buying and what happens if your China supplier fails to comply. See China Contracts: Make Them Enforceable Or Don’t Bother and China Contracts that Work.
  • Know the market price of whatever it is you are seeking to purchase before you purchase it. Do not trust a company that gives you unreasonably low price quote.
  • Consider a small trial order to reduce your risk. The problem with this though is that many scammers will provide you with a good trial and then scam you when you order the full amount. But if you combine this with a contract that works for China and proof that the company actually exists and is operating legally, you will be lowering your risks.

One more thing that warrants its own special mention. Do not buy product from China without first registering your trademark in China because many of the fraudsters that are sending out bad product are now also registering YOUR brand name and/or product name and/or logo in China as THEIR trademarks in China and then coming back later seeking to sell you these trademarks (for a lot of money) under threat of blocking your products from leaving China for violating THEIR trademarks. See 8 Reasons to Register Your Trademarks in China. We do not have concerte proof that it is the same people both times but it has happened far too often for me to ascribe it to coincidence.

An ounce of prevention is worth a pound of cure.


China product defect lawyersAs most of you already know, getting defective products from China manufacturers is almost always a possibility. In many cases, foreign buyers frustrated by bad product simply refuse to pay their Chinese factory. Often the unpaid amount is substantial. The foreign buyer then moves on to a new factory. This new factory is often located in the same general region as the former factory. The Chinese factory virtually never files a lawsuit in this situation. So the foreign buyer then starts believing it is off the hook. But in China, matters like this are almost never that simple.

Most factories in China work with a network of subcontractors. So an unpaid invoice to a single factory usually will impact a large number of smaller businesses. Sometimes even an entire village will be impacted by one failure to pay. When the nonpayment is in a significant amount, the failure to pay can mean the salaries of many (sometimes most) of the local residents do not get paid. This leads to social unrest, which is a major concern of the local authorities, who then seek to work with the factory to try to secure payment. The legal issues (like the defective product) are not of concern. The factory and the local authorities will simply seek funds required to calm down the local unrest. These matters are not usually viewed as a business dispute and the court system is seldom used to try to resolve it. The factory never tells anyone the reason for non-payment was defective product; it instead almost always blames nonpayment on an unjustified default by the foreign buyer.

So long as the foreign buyer remains outside of China, there is little the factory and the local authorities can or will do. However, if the foreign buyer or an employee of a foreign buyer travels in China, the risk of some form of non-court or openly illegal action being taken against the foreign buyer is high. For this reason, we advise our clients to take great care when traveling in China if there is any dispute about their having failed to make a payment of a substantial claim to a Chinese factory. This is particularly important when the factory is a major employer in a specific district. The risk level rises exponentially if the foreign buyer travels in any area close to the district where the factory is located.

So what can happen?

a. Hostage taking. The Chinese side will arrange a meeting to take place at the factory or in a hotel that cooperates with the factory. The factory staff will obtain the passport of the foreign buyer. After the passport is obtained (stolen or taken by force), the factory holds the buyer captive either in a factory dormitory or in the cooperating hotel. The Chinese call this a “soft kidnapping” because no physical threats are made. The factory simply states: we won’t let you leave until after you pay the bill. If the police are contacted, the police will usually say: “It’s none of our business. You should pay the bill.” If the local authorities are contacted, they will usually say “It’s none of our business. You should pay the bill.” Resolving the matter without making payment is nearly impossible.

b. Exit ban. Because of the potential for social unrest, the Chinese authorities usually will work to assist the Chinese factory in getting paid. One way they do this is through an exit ban. The foreign buyer is permitted to enter China, but when the buyer seeks to exit China, permission will be refused. The foreign buyer is told: “You will not be permitted to leave until after you have resolved your payment dispute with the factory.” Exit bans are only approved at the national level and a factory that makes a false claim will be penalized. This is why hostage taking is more common.

So what is to be done?

The easy way to resolve the matter is to pay the entire claim in full. In the alternative, the foreign buyer can avoid being taken hostage or an exit ban by staying out of China. Often neither of these solutions is practical.

So what happens most often is that a partial payment is made pursuant to a settlement of claims agreement. For a settlement to work well, the basic rules are as follows:

  1. The agreement must be in Chinese and enforceable in China. Chinese authorities typically ignore English language agreements enforceable outside of China.
  2. It is normal to include in such an agreement standard settlement language: the creditor takes payment in full settlement of all claims; the creditor agrees not to file a legal action anywhere in the world; the creditor agrees to maintain confidentiality; the creditor agrees not to contact any PRC government authority.

If you have a settlement agreement that meets these above rules the local police and the exit authorities will normally take the side of the foreign buyer and you should be safe from being held hostage or blocked from leaving China. If the payment settlement agreement does not comply with the above rules, it is a waste of time and paper and money.

In general, in the case where there is payment in full or the case of a partial payment under an enforceable written settlement agreement, the risks I write about above will be resolved. I have never experienced an instance where a Chinese entity took anyone hostage or pressed for an exit ban after getting paid and signing an enforceable written settlement agreement. For this reason, even though our China lawyers we have drafted dozens of these settlement agreements, none of us have any experience in having to provide one of these settlement agreements to PRC authorities to try to convince them to free a hostage or lift an exit ban after a formal settlement has been reached.

But on the flip side we also have a lot of experience with companies that have either made a partial payment to their Chinese factory without getting a written settlement agreement or getting a written settlement agreement that does not comply with the two rules set forth above. Our experience in these situations has been uniformly bad and in most instances our clients have had to pay the full amount allegedly owed (and fast) to resolve their crisis situation.

Even in those cases where the reason for non-payment is because of product defects, no authority in the PRC will accept a simple claim from the buyer on this issue. The only way to be sure the PRC authorities will take any notice of the defect claim is by the buyer filing a lawsuit in its home country or (even better) in China making a claim for the defect. Anything short of that will simply be ignored. You can show the Chinese authorities a pile of emails 10 centimeters thick and they will be ignored. You can show them an inspection report and that will be ignored. The only thing they will get their attention is a formal lawsuit with service pursuant to the Hague Convention brought by you against your China supplier. We have done many kidnapping negotiations where our buyer-clients believed they could make the claim that nothing was owed due to defect. This claim never works. The police just laugh and walk away. The local government officials just hang up the phone. On the other hand, presenting evidence of formal legal proceedings where service was properly provided has always worked.

As they say on the cop shows, “Let’s be careful out there.”

For more on dealing with defective products from China check out the following:

China and Hong Kong legal systems
For commercial law purposes, think of Hong Kong as a different jurisdiction from the Mainland

In an effort to reduce the challenge of manufacturing in Mainland China, many foreign companies decide not to go direct. They instead make use of intermediary companies that act as the sellers in the transaction. These intermediaries deal with the buyer, but the messy business of manufacturing is done in the PRC. These intermediary companies are often located in Hong Kong. We have seen that most foreign buyers do not understand the risks involved in dealing with Hong Kong companies and this too often causes them to unknowingly take on significant risks. One of those significant risks arises in the area of intellectual property protection.

From the standpoint of legal jurisdiction, Hong Kong and the PRC are two entirely different countries. The most important result of this legal distinction is that foreign investment in the PRC by Hong Kong companies and individuals is restricted in the same way it is restricted for American and European and Australian companies. This means Hong Kong companies cannot operate directly in the PRC. To operate legally in the PRC, a Hong Kong company must form a WFOE or an Equity Joint Venture, in the same way as for any other foreign entity. See How to Form a WFOE in China, Part 3: What’s Hong Kong Got to Do With It?

What does this mean in the manufacturing setting? The foreign buyer enters that enters into a contract with a Hong Kong company is (999 times out of 1000) not entering into a contract with the actual manufacturer because the actual manufacturer is a company located in the PRC. The actual manufacturer is a legal entity entirely separate from the Hong Kong company. To make this clear, in the manufacturing contracts drafted by the China lawyers at my firm, we call the Hong Kong company the “Seller” and the PRC manufacturer the “Factory.”

Now consider what all of this means from the standpoint of intellectual property protection. The foreign buyer provides its proprietary design to the Hong Kong seller. Complicated molds embodying the proprietary design are fabricated. Extensive engineering and production design work is conducted to develop a working product prototype. But, none of this work is done by the Hong Kong-based Seller because all of this work is being done by the factory in the PRC. This work is almost always being done by entities unknown to the buyer and with which the buyer has no contractual relationship. The molds and tooling and product prototypes are physically located in the PRC.

The result is that the buyer has given away its most valuable intellectual property to persons and entities it both does not know and cannot control. So what happens if something goes wrong? What happens if the buyer wants access to the molds to transfer production to another factory. What happens if the buyer learns the molds are being used to make “knock off” products? What happens if the buyer learns the product prototype is being used in the PRC to manufacture a competing product? These are not trivial questions as these things happen every single day in the PRC. The answer is that the buyer has no recourse at all in the PRC. The only legal action the buyer can take is against the Seller in Hong Kong. In the intellectual property area, this means the only thing the buyer can do is to sue for damages. The buyer can take no direct action against the infringer nor does it usually have any good legal basis to prevent the infringement happening in the PRC.

Now add to this that in most cases (at least most instances — by far — where companies have retained my law firm to investigate the above sort of situations), the Hong Kong Seller has no real assets. The Seller is no more than a small office with a phone and computer and sometimes a small sales staff. All the productive assets are located in the PRC, in the hands of companies and individuals with no direct legal relationship to the Hong Kong entity. Cash received by the Hong Kong entity is regularly swept into separate accounts with no direct relationship to the Hong Kong entity. In litigation terms, the Hong Kong entity is judgement proof.

What this all means is that the foreign buyer has essentially given away its intellectual property. The intellectual property is in the hands of a company in China and nothing can be done in China if the intellectual property is misused in some way. For physical items like molds, tooling, and prototypes, the items are gone forever. The PRC entity may refuse to return the items. The PRC entity may pass the items on to its subcontractors, who then further pass the items on to a subcontractor or family friend. In the end, it is not unusual to find that no one knows the ultimate fate of the items. But what is known is that the items are located in the PRC and the buyer has no legal recourse in the PRC. The buyer has nothing more than a claim for monetary damages against a Hong Kong entity likely to be judgment proof.

A foreign buyer that fully understands the risks may make the business decision to incur the risk. However, in our own work in Asia, we pretty much never encounter U.S. or European buyers that understand the situation. Most simply assume that when they contract with a Hong Kong entity, their legal situation is no different than if they were contracting with a PRC entity. They have already decided to incur the risk of manufacturing in the PRC and they see working with a Hong Kong entity as a way to reduce that risk, not increase it. They assume the Hong Kong entity will be easier to communicate with and that because Hong Kong’s legal system is better, they and their IP will be better protected this way.

But in reality, the foreign buyer has not reduced its risk. It has instead dramatically increased it. If the increase in risk is intended, that is part of the commercial calculation. But when the increase in risk is based on a fundamentally incorrect understanding of the law and the facts, it is nothing more than a mistake.

For more on why it is important to distinguish Mainland China from Hong Kong, check out the following:

Negotiating China contracts
Negotiating contracts with Chinese companies

When negotiating a contract with a Chinese party, firm deadlines are essential, but also dangerous. They are dangerous because many (most?) Chinese companies have mastered the technique of manipulating deadlines to their advantage.

There are many reasons to set a deadline for concluding a contract with a Chinese party. In any deal where the Chinese side will be required to make a payment, such as the purchase of an offshore asset, the Chinese side will tend to delay making a final decision. Setting a tight contract deadline controls this tendency. On the other hand, when the money is flowing in the other direction, the Chinese side will often impose an artificial deadline unrelated to the deal. In my experience, the most common is for the Chinese company to assert that the deal must be done on a specific date because a public signing ceremony has already been scheduled.

If you are negotiating with a Chinese company that has set a deadline for completion, you need to be prepared to deal with what is now the fairly standard Chinese program for manipulating contract deadlines. Without regard to who set the deadline and without regard to why the deadline has been set, you must be willing to simply walk away from the deal if all of the terms and all of the drafting is not complete on the deadline date. If you are not willing to simply walk, then you will be manipulated by the Chinese side.

The standard program Chinese companies use for manipulating a deadline usually works in three stages, as follows:

Stage One: The first draft of the contract is always submitted by the foreign party. The Chinese company never provides the first draft because that would require they “tip their hand.” The foreign party works overtime on a tight timeline and provides its draft thirty days before the deadline. This is done under the assumption that thirty days is sufficient to work out all the deal issues and arrive at a final draft agreement on the deadline date.

The foreign party hears nothing, not even an acknowledgment of receipt. This causes concern and after three or four days the foreign party asks the Chinese side about receipt and comments. The Chinese side responds that it did a quick review and everything looks okay. The foreign party is relieved and begins preparing to implement the project on the terms stated in the draft contract.

Stage Two: Seven or so days before the deadline, the Chinese side finally sends its comments on the draft agreement. At this stage, the Chinese side proposes two or three changes. However, these changes are designed to make the contract completely unenforceable against the Chinese side. Here are my three current favorites:

1.  The key to the contract is that the obligations provided in the contract are absolutely binding on the Chinese party for a period of three to five years. The Chinese side makes no revision to the 35-page contract. Instead, they insert a single article that provides that the Chinese side can terminate the contract at will on 30-days notice.

When challenged, the Chinese side claims mutual termination is common in international contracts.

2.  The Chinese side adds what it calls a force majeure provision. The standard force majeure provision provides that neither side can be compelled to perform in situations where performance is impossible due to matters outside the control of that party: war, strike, typhoon, earthquake. The key to a standard force majeure provision is that neither party is required to perform. If the force majeure condition continues, the affected party is required to return the matter to the pre-contract status quo.

The Chinese provision is always written in a way that stands the standard force majeure provision upside down. In the Chinese version, the Chinese side is concerned only with the actions of the Chinese government. The Chinese force majeure provision will provide that if the Chinese government or its agents (foreign exchange bank) makes performance by the Chinese side impossible, the Chinese side is not obligated to perform. But the foreign party is still obligated to perform and the Chinese side is not obligated to return the matter to its pre-contract status quo.

When challenged, the Chinese side replies: force majeure provisions are standard in international contracts.

3.  In the critical provisions of the contract, in every place where it says “the Chinese party shall be obligated to do” the contract is revised to say “shall not be obligated to.” This is usually done where the revisions are not redlined or otherwise identified in a cover memorandum. The added word is only located after careful review of the contact. The longer and more detailed the contract, the more difficult it is to find this kind of revision.

When challenged, the Chinese side replies: we only inserted one word. What is your problem with that?

When the foreign side objects, the Chinese side will complain that the foreign side is being unreasonable. If well advised the foreign side will hold the line and refuse to agree to revisions like these that will essentially render the contract meaningless. The Chinese side then agrees to back down and the foreign side then feels relieved, assuming the agreement as drafted will be executed on or before the deadline. The unsuspecting foreign party does not realize that the opposite will almost certainly happen, leading to stage three.

Stage Three: Two to four days before the deadline, the Chinese side returns the contract with extensive revisions throughout the entire document, usually with no redline of the revisions. Some Chinese parties will redline some but fail to redline others. No explanation is ever given for the large number of revisions. No explanation is ever given for why these revisions were provided so close before the deadline when it is clear the Chinese side was aware of the issues weeks earlier when the draft was first provided to it.

Most foreign parties at this stage fall directly into the trap laid by the Chinese side since day one The foreign party works desperately to revise the document in the face of the by now ridiculously short deadline. In this setting, the Chinese side is hoping two things will happen. First, the foreign side will make concessions just to get the document signed. Second. the foreign side will make drafting mistakes due to the short timeline and the need to work in two or more languages. The Chinese side will then ruthlessly take advantage of those mistakes at a later date.

It is always a mistake to fall into the deadline trap. The better response is to realize from the start that the deadline is not relevant to the Chinese side. The Chinese side is merely using the deadline as a tool to gain an advantage over you. The first step when faced with this trap is to refuse to make the revisions and execute the agreement under this time pressure. Instead, tell the Chinese side that since they are the ones who responded late, you view their response as a contract rejection and for this reason, the deal is off.

Then simply walk away. Do not propose a new deadline. If you propose a new deadline, the Chinese side will go through exactly the same steps (as above) in almost exactly the same way. The only useful course of action is to tell the Chinese side that if it is still interested in doing the deal it should come back with a reasonable set of proposals and if we are still interested, we will take a look. But, since the deadline has passed, we may never come back to you. It is your risk.

In that situation, some Chinese parties will simply capitulate and come back with a reasonable set of proposals quite soon, often within one week. However, the most common response is that the Chinese side will continue to act in a manner designed to force the foreign party into making an unreasonable concession or a mistake. The only way to prevent that is to treat the deadline as a hard date and to walk away when the Chinese side is unreasonable.

It is impossible to predict what the Chinese side will do when you walk away. The Chinese side is not using this three-stage technique because it is inexperienced. The opposite is true. These entities are very experienced and they have learned that the deadline manipulation technique works very well. The only appropriate response from the foreign side is to call the bluff by walking away. But like a poker game with a stranger, you never know what will happen when you call the bluff. The response from the Chinese side is entirely unpredictable.

Be prepared.

China NNN Agreements
China NNN Agreements. So many choices.

Good sourcing agents are both hard to find and worth their weight in gold. And they operate in many different ways. On one extreme, a sourcing agent will find a factory, take a finder’s fee and then bow out, letting you deal with the factory directly. On the other extreme, a sourcing agent will act as your exclusive point of contact: you order from them, communicate with them, and pay them, and are expressly precluded from having contact with the factory. Most, however, fall somewhere in between.

The multitude of potential arrangements creates uncertainty about the appropriate contractual protections. That is: should you have an agreement with the sourcing agent, the factory, or both? And what type of agreement?

We are big fans of using NNN agreements in China with potential business partners (especially factories). Knowing this, our clients will sometimes come to us and say that they are having goods manufactured in China and they need an NNN agreement for use with everyone. It’s not that this is per se incorrect, but it’s often putting the cart before the horse. An NNN agreement is not the proper agreement in every situation.

If you don’t know the identity of the factory manufacturing your goods, an NNN agreement with them is out of the question. You can’t enter into a contract with an unknown company! And if you have a complicated arrangement with a sourcing agent or a factory, then an NNN agreement won’t go nearly far enough.

In short, the arrangement you have with your sourcing agent will determine the agreements you need, and with whom. We addressed these issues last year in China Manufacturing: To Broker or not to Broker, That is the Question, with particular attention to the question of whether you could (or should) have a contract solely with your sourcing agent. It will probably not surprise you to hear that the answer is: it depends.

In an ideal world, if you are dealing with factories directly, you would want NNN agreements with the factories with which you have initial talks, development agreements with the factories that develop products for you, and OEM agreements (aka contract manufacturing agreements) with the factories that actually manufacture products for you. In this situation, the agreement with the sourcing agent would be fairly simple because they aren’t doing much – it’ll basically be an NNN agreement with some additional verbiage to cover the finder’s fee. You don’t want the sourcing agreement to be the only agreement in place, because it offers so little protection.

If you are dealing exclusively with your sourcing agent, then you won’t – can’t – have any agreements with the factories. You will need to look to the sourcing agent exclusively for everything: non-competition, non-circumvention, non-disclosure, quality control, ordering, warranty, etc., because you have no contractual privity with the Chinese factories and no way to hold them responsible for anything. This can be useful if the sourcing agent is based in the United States because it is a lot easier to go after a US company. But this presupposes that the US company has assets, and that your agreement with them allows you to hold them responsible for the actions of the Chinese factories. In this situation, the sourcing agreement is all-important and must be carefully drafted, because many sourcing agents will attempt to avoid responsibility for everything from delays to quality issues to IP infringement. Working with these agents is taking a huge risk: if the sourcing agent isn’t responsible for the actions of the Chinese factories, and you don’t even know the identity of the Chinese factories, you’ve got no recourse if things go south.

For all of the sourcing agents in between, you’ll want a robust sourcing agreement and at the very least NNN agreements with the factories. Whether the development and manufacturing agreements are with the factories or the sourcing agent will depend on the particulars of how you deal with the various parties, and also your ability to hold them responsible when things go wrong. If the sourcing agent is a well-established company with multiple employees and a real office and sizable assets, it’s reasonable to look to the sourcing agent for everything. If it’s one guy with a virtual office in Los Angeles who spends most of his time overseas, not so much. Of course, the ideal situation from a legal standpoint is not always possible in the real world, so you need to adjust to the situation on the ground.

Some clients ask our China lawyers if they can just have NNN agreements “with everyone” and leave it at that? Certainly, it does not hurt to have NNN agreements with every party on the sourcing agent/manufacturer side. But it won’t cover all potential forms of liability – not even close. It will only hold counter-parties liable for misuse of your IP. For some clients, this is enough, particularly during initial phases when they are unsure whether their IP can really be commercialized.

And no matter what agreements you sign with your sourcing agent and factories, you still need to register all of your IP (patents, trademarks, copyrights) in China. You could have an ironclad agreement with a great sourcing agent who only uses wonderfully compliant factories, and it won’t mean a thing if some third party registers your trademark or copies your patented goods.

China AttorneysBecause 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 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 super fast general answer and, when it is easy to do so, a link or two to a blog post that may provide some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

Our China attorneys frequently get phone calls and emails from people wanting to know what they should discuss with Chinese manufacturers they are considering for their manufacturing.

In response to this question, I usually send out the below list which succinctly sets forth the bulk of the terms most companies should be concerning themselves with when outsourcing their manufacturing to China. These are the sorts of things that need to  go into your China Manufacturing Agreement.

Not everything on this list will be relevant to your company and obviously some items will be more important to  you than others. This list is in English only and once you have honed it to suit your particular situation, it oftentimes will make  sense for you to put it into Chinese as well, so as to  reduce the likelihood of any misunderstandings. The terms set forth below come from a very lage and very sophisticated  client of ours and they are very much particularized to the particular industry, the particular situation, and the particular company. Your mileage will most definitely vary. My goal in providing this list is more to get you thinking about what’s important for your company than anything  else.

For more on China manufacturing term sheets, check out China OEM Manufacturing Agreements. What Should Go In Your Term Sheet? and China OEM Agreements. Ten Things To Consider.




Very short description of product goes here.

1 year with automatic annual renewal; provided BUYER may terminate without cause on 60 days written notice and SELLER can terminate without cause on 180 days written notice.



Yes, during the term of the agreement, as long as SELLER can meet capacity and quality requirements; provided, BUYER may manufacture its own devices at its own manufacturing facility.



BUYER’s requirements; provided, BUYER supplies a 6-month, non-binding rolling forecast and a 3 month binding forecast.  Forecast will be provided 3rd day of each month.   BUYER willing to agree to a reasonable production cap reflecting anticipated demand.



Must be placed no later than 45 days prior to requested delivery date; SELLER may not reject any order.



First 2 POs, we will pay 30% of purchase price when PO placed and the remaining 70% will be paid 30 days after the shipment received.  Remaining shipments in first  year net 30 days from receipt of invoice.  After first year, net 60 days from receipt of invoice.



FOB Port (Shanghai) to BUYER’s designated marine carrier; risk of loss and title to pass to BUYER upon delivery to carrier.  Time is of the essence.  SELLER responsible for any fines incurred by BUYER from retailers for late delivery caused by SELLER (as long as PO placed sufficiently in advance of required lead time).  SELLER will properly complete all shipping documents and maintain a record of such documents for 3 years after delivery.



SELLER will properly label all shipping documents with the customs classifications codes supplied by BUYER.



To be agreed upon and will be set forth in schedule. SELLER cannot increase pricing without BUYER consent.  All prices stated in US dollars and payments made in US dollars.  Parties will meet and confer every 6 months to review pricing and determine whether price change warranted. 



SELLER will continually endeavor to reduce costs of manufacturing, packaging and shipping to port.  All savings to be split 50/50 between SELLER and BUYER (savings already addressed in development agreement)



All finished products and every individual part used to manufacture or package the products must meet BUYER specifications, which will be attached to and form a portion of the agreement.  If a supplier changes a specification to a commodity or part used to manufacture product, the change must be communicated to and approved in writing by BUYER.



Each and every part used to manufacture, label, or package the products must be approved in writing by BUYER. SELLER may not change a part without BUYER’s written consent.  All materials and parts suppliers must also be approved in writing by BUYER and represent in writing that are in compliance with wage regulations of their jurisdiction of manufacture and that they do not use child, slave or prison labor to make their materials and parts.




Must meet all BUYER requirements (to be supplied by engineering).



BUYER shall provide SELLER with FCPA compliance manual and SELLER shall abide by it.



SELLER will be responsible for ordering all materials and parts and maintaining an adequate inventory to meet forecasted demand.  SELLER will be responsible for all costs of storing and maintaining inventory.  In the event of termination or expiration, BUYER shall pay SELLER for the reasonable wholesale cost of any materials or parts that are custom made or unique to the BUYER products.



SELLER to maintain 30 day supply of each type of product at all times at its cost.  BUYER has no obligation to pay for it until it is delivered to BUYER’s carrier.  BUYER will buy back safety stock remaining within 60 days of expiration or termination of agreement.



Addressed in Development Agreement



BUYER will have the right, no less than twice annually, to conduct unannounced quality assurance inspections of SELLER’s facilities and books and records to ensure compliance with this agreement.



Addressed in Development Agreement.



All parts and finished product shall be warranted free from defects in materials, workmanship and manufacturing for a period of one year from date of manufacture.  BUYER will have option of repair, replacement or refund and can return defective product at any time within 1st year regardless of when discovered by BUYER or its customers.  SELLER responsible for all costs to return defective product to SELLER.



SELLER to indemnify BUYER for:  (1) all actions and omissions of SELLER and Employees; (2) manufacturing and materials defects; (3) BUYER’s breach of agreement, reps and warranties; and (4) damage to Tooling caused by SELLER.



SELLER will maintain a US-based policy of insurance, including CGL, products and completed operations of not less than $1MM per occurrence with an umbrella of not less than $30MM.  Must maintain during agreement and for 10 years thereafter.



Neither party liable for consequential, special or incidental damages or lost profits, or business opportunity.



CONFIDENTIALITY  Subject to NNN Agreement and will tie the OEM to NNN.

Limited to manufacturing only.  SELLER can’t use for own benefit and will inform BUYER if it discovers use of BUYER’s IP by any 3P.  Will reasonably assist BUYER in asserting any rights BUYER may have against such 3P.



SELLER may not assign obligations under agreement (even in connection with change of control) without BUYER consent.  BUYER may freely assign.


LABOR No slave, prison, child labor.  Wages in accordance with all applicable laws.

China lawyersSmart Chinese manufacturers know that with their costs rising, they need to be able to distinguish themselves from their peers. One of the ways they are choosing to do this (even more frequently than in the past) is by copying and selling products they are making for their foreign customers. See Your China Factory as your Toughest Competitor. 

Why is this so dangerous? Because bad things nearly always happen when Chinese manufacturers discover their American/European/Australian product buyers will soon be ceasing to buy from them. For this reason, we instruct our clients to line up their new suppliers and have them ready to go, before even hinting that they might be having a problem with their Chinese manufacturer that may lead them to seek out another supplier. We are giving this same advice to companies that come to us wanting to switch suppliers after having learned that their existing supplier is copying and selling their products.

We give this advice because over the years our China lawyers have repeatedly seen the following:

  • Western company tells its China manufacturer it will be ceasing to use China manufacturer for its production. China manufacturer then keeps all of the Western company’s tooling and molds, claiming to own them. The way to prevent this is to get an agreement from your Chinese manufacturer that you own the tooling and molds before your Chinese manufacturer has any inkling that you will be moving on. For more on the importance of mold agreements, check out How Not To Lose Your Molds In China and Want Your China-Based Molds? You’re Probably Too Late For That.
  • Western company tells its China manufacturer that it will be ceasing to use China manufacturer for its production. Western company then learns that someone in China has registered the Western company’s brand names as trademarks in China. Western company is convinced that its China manufacturer is the one that did these registrations, but has no solid evidence to prove this. Western company is now facing not being able to have its product — at least with its own brand name — manufactured in China. See 8 Reasons to Register Your Trademark in China.
  • Western company tells its China manufacturer it will be ceasing to use China manufacturer for its production. A few weeks later, Western company has its products seized at the China border for violating someone’s trademark. The Western company is (rightly) convinced that its China manufacturer is the one behind the product seizure, believing the Chinese manufacturer registered the Western company’s brand names as trademarks in China long ago and is just now using that trademark to seize product as revenge. China has laws forbidding its manufacturers from registering the trademarks of those for whom it manufactures, but because it is usually not possible to prove that your manufacturer in Shenzhen had a cousin in Xi’an do the registering, this sort of thing goes on unchecked. This sort of thing is increasingly happening with design patents as well. For how to prevent this from happening to you, check out the following:
  • Western company tells its China manufacturer it will be ceasing to use China manufacturer for its production. China manufacturer then says it will not be shipping any more product because Western company is late on payments and owes X hundreds of thousands of dollars. China manufacturer then reports Western manufacturer to Sinosure and Sinosure then ceases to insure product sales to this Western company, which can have the effect of convincing Chinese manufacturers not to sell to the Western company without getting 100% payment upfront. For more on Sinosure’s role regarding China exports, check out China Sinosure: What You Need to Know.

So yes, switching your China manufacturer can be risky, at least when done without sufficient planning.

China Lawyers
There’s nothing we can do.

I had no idea what I was going to write about this morning, but thanks to one of our China lawyers updating me regarding the following email exchange, I have a ready-made post.

The email exchange started with the following email (modified to hide any identifiers) from a U.S. company having problems with its China manufacturer:

What do you suggest when a supplier is holding products hostage on a PO to try to get us to place larger future orders at inflated prices.

Our China attorney responded as follows:

That you are writing us (and not your regular attorney) makes me think you have almost no grounds on which to stand. I say this because 99.99 percent of the time this is true of those who write us with manufacturing problems. You are probably too late to remedy this problem with this manufacturer because the only good fix of which I am aware is a manufacturing contract (in Chinese, sealed by your Chinese manufacturer, and with a China court jurisdiction provision) that explicitly prevents this. POs are pretty worthless. Unless you have a contract (in Chinese) that clearly lists out this and that, there is probably little to nothing you can do. See China Contracts that Work. A good China manufacturing contract should also contain a liquidated damages provision, a mold protection provision (so that the factory does not keep your molds if there is a dispute, see Product Molds And Tooling In China: Three Things You Must Do to Hang on to Yours), be properly chopped/sealed (see Signing And Chopping A China Contract. It’s Complicated). It is also critical that your contract is with the right Chinese company as Chinese companies are notorious for signing agreements with an essentially empty shell company, usually based in Hong Kong. And as you have learned here, it also must include pricing and product delivery provisions.

If someone were to contact us with all (or at least most) of the above in line, we would be happy to assist them in dealing with their China manufacturer. But — and here is the kicker — nobody ever has, and there are three simple reasons for that. One, if they had a contract that contained all of these things they likely would never have had the problem in the first place. Two, if they had a contract that contained all of these things and they did have a problem, they would be in a position of sufficient power that they probably could get their Chinese manufacturer to capitulate without the need for an attorney. And three, if they had a contract that contained all of these things, they would simply go back to the lawyer that drafted it (and not to a new lawyer) for assistance.

There is typically an even bigger issue that we always point out when someone comes to us with a manufacturing problem like the above. Whenever someone has any problem with their manufacturer, one of the first questions we ask them is whether they have registered their trade names and logos as China trademarks. We ask this because many times (like well over half) when foreign companies start having problems with their Chinese manufacturer, their Chinese manufacturer has already gone off (using an apparently unrelated third party) and registered the trade names and the logos of the Western company with which it created the dispute. Chinese manufacturers do this to gain leverage and this really works because your Chinese manufacturer can use “your” trademarks to stop you from having your products manufactured in China or shipped out of China with your own brands and logos on them. See When to Register your China Trademark. Ask Tesla and China: Do Just One Thing, Trademarks. Or, as is usually the case, it will use “your” brand name and logo to sell your products in countries where you do not have trademark protection. So if you have not already registered your brand names and logos in China, you should do this IMMEDIATELY (you very well could already be too late) and you should do so before you complain any more to anyone there. And you also should register your brand names and logos in whatever countries in which you sell (or will sell) your products as well.

China manufacturing protection is possible, but just sending out POs and thinking you have it is just wrong. Sorry.


China Manufacturing Agreements
China Manufacturing Agreement Questions

Our China lawyers are always working on some China manufacturing matter or another. Those matters typically involve what I internally call the manufacturing trifecta: China NNN Agreement, China Manufacturing Agreement, and China Trademark.

For each of these matters (and for just about anything we do), the first thing we try to do is to get a general sense of the client and the project. We typically achieve this by starting out with a broad set of questions that are loosely tailored to the client and the client’s project, with very few assumptions by us.

Once we receive and analyze the client’s answers to our broad questions, we then come back with a set of hyper-focused questions, the answers to which should allow us to start drafting the contract or filing the trademark. The below is a slightly revised email that went out this week to a client regarding its China Manufacturing Agreement. I am running it here because it nicely highlights some of the basic issues that go into manufacturing in China and, correspondingly, some of the basic issues that go into drafting a China Manufacturing Agreement.

To get started, please provide the following basic information:

Please provide a basic statement in reasonable detail regarding your plan for your manufacturing project in China. This statement should include at least the following:
a. What is the product or products? How will you provide specifications for this product or products? I note that your company sells a large number of products. Which of these, in general terms, will be made in China?
b. Who will be manufacturing this product or products? What is the current status of your relations with your Chinese manufacturers?
c. What quantities per year will you be buying of this product or products?
d. Will you be using one factory or several factories?
e. Do you design the product or products, or do you brand Chinese designed product, or do you do both?
f. Who is responsible for production design? Who will own the result of that design process?
g. How do you plan to monitor the manufacturing process?
h. What entities will be the retail customers for the product or products? Will you sell a) to distributors, b) to retailers, c) direct to the public? Or some combination of these?
i. What are the pricing and payment and shipment terms?
j. How do you deal with basic business terms: price, quantity, delivery dates and similar?
k. What registered IP do you have that is embodied in the product or products? Where is such IP registered? IP means patents, trademarks, copyrights, and trade secrets.
l. Do you make use of molds, jigs or other tooling in the manufacturing process? If yes, what is your current procedure for dealing with such items?
m. What are your specific business concerns related to manufacturing in China?
After I get your responses to these questions, I will then provide you with a more focused set of questions.