Product sample contractIn Part 1 of this series, we wrote about how the product development stage is fraught with risk for foreign companies manufacturing overseas and yet frequently neglected. In Part 2, we wrote about how foreign companies \routinely use NNN agreements in the factory search stage and Manufacturing Agreements (ODM, CM and OEM) for the production stage, but rarely use Product Development Agreements during the product development phase because they often do not realize they are in that stage or because they believe their NNN Agreement will protect them. We then explained why this often is a big mistake, the results we often see from this “big mistake” and, most importantly, how to avoid it. In Part 3, we wrote about how when manufacturing overseas, the manufacturing contracts that make sense for you and your company are the manufacturing contracts that make sense for YOU and that is not usually going to be what you read on the internet nor what some other company tells you it did nor what you tell some law firm you need nor what some law firm wants to sell you.This part 4 is a riff on an interview I did for Global Sources the other day focused on getting a product sample before you buy. This interview is titled, Expert talk part 3, Dan Harris: Buy samples, cover all the bases and its preface notes how a “common thread” with my two previous interviewees was that “product samples can spell the difference between a successful sourcing journey and an importing disaster.” It then gives the following quotes from the two previous interviewees:
  • As John Niggl put it, “Buyers who skip the product sampling stage do so at their own peril. The benefit that comes from being able to “try before you buy”—review and approve a sample before committing to an order—is simply too great.”
  • Gary Huang, meanwhile, underscored the importance of product samples by comparing it to an audition where you can get a glimpse of quality and capability.

Well I’m here to tell you somewhat the opposite. Product samples are overrated. Sort of.

I am not going to deny that product samples are valuable and I am not going to tell you not to get product samples. No. Product samples are valuable and you should get them. But, from a legal perspective, they can be both highly risky in terms of your IP and worthless in terms of protecting you from bad quality.

Let me explain via the interview, with the interview questions in italics and my answers in normal font (modified slightly to enhance your reading pleasure)

Global Sources: What’s your take on buying product samples from overseas? What are the challenges?

Dan Harris: As a lawyer, three things always scare me about foreign companies having a sample made by an overseas factory:

First, does the foreign company have an enforceable agreement that will stop the overseas factory from copying the foreign company’s product and selling it around the world?

Second, did the foreign company apply for a trademark in the manufacturer’s country (China, Vietnam, Thailand, Indonesia, etc.) before it revealed its brand name to its manufacturer? This is critical because the first to apply for a trademark in most countries gets it, regardless of whether the foreign company previously registered its trademark in its home country. See e.g., China Trademarks: Register Yours BEFORE You Do ANYTHING Else.

Third, many foreign companies just assume that if they get a good sample the products will match the sample and if they do not, they will be legally protected. Neither of these are true, though.

Global Sources: Do you have a story of sample orders gone wrong?

Dan Harris: Our manufacturing team have definitely seen nightmare scenarios. The most common is when a foreign company has an overseas factory make the molds and make the sample and then learns that the overseas factory is using the molds for itself and selling the product either to competitors of the foreign company or direct to consumers.

Often when this happens (surprise, surprise), the overseas factory is also supplying bad quality products to the foreign company. This way the overseas company can not only sell the foreign company’s own products, it can sell better quality products than the foreign company.

Global Sources: Despite these challenges, what benefit do buyers get out of product samples?

Dan Harris: You can use samples to determine whether the factory is capable of meeting your quality standards. The problem is that one factory might have another factory make your sample and then pass it off as its own. This is particularly common in China where factories are so often clustered by product. Foreign company buyers should be certain to protect their IP by using an enforceable NNN Agreement and by seeking to register their company name, brand name and logos in the country in which their manufacturer is located and they should do this before they reveal any of those to anyone overseas. See e.g., China Contracts: Make Them Enforceable Or Don’t Bother. And if you are going to legally obligate your overseas factory to make your products to the specifications of your initial sample, you need an enforceable written contract mandating that it do so.

Global Sources: A buyer gets samples from three or more manufacturers. All samples meet his requirements and he’s satisfied with quality? Which manufacturer does he work with?

Dan Harris: I am a big believer in having the client visit the factory and meet with the people in person. This usually tells you a lot. See Overseas Product Sourcing: Being There.

Global Sources: How can Harris Bricken [my law firm] help buyers with the sample order stage?

Dan Harris: We help with the contracts and the IP registrations. I have to note that the biggest change we have been seeing from our clients in terms of buying products from overseas is that they very much want to start buying from countries in Asia beyond China (such as Vietnam and Thailand and Indonesia and the Philipines) and from Eastern Europe and Latin America.

Bottom Line: Product Samples can be great for determining whether an overseas factory has the capability to make your product at the quality you want, so long as the product sample you are given actually comes from the particular overseas factory with which you are dealing. But just getting the sample has its IP and other risks against which you should be protected early.

International trade lawyersOn March 6, 2019, The American Kitchen Cabinet Alliance, consisting of 27 United States domestic producers, (Petitioner), filed antidumping (AD) and countervailing duty (CVD) petitions against Wooden Cabinets and Vanities (“Wood Cabinets”) from China. A copy of that petition can be found here.

Under U.S. trade laws, a domestic industry can petition the U.S. Department of Commerce (“DOC”) and U.S. International Trade Commission (“ITC”) to investigate whether the named subject imports are being sold to the United States at less than fair value (“dumping”) or benefit from unfair government subsidies. For AD/CVD duties to be imposed, the U.S. government must determine not only that dumping or subsidization is occurring, but also that the subject imports are causing “material injury” or “threat of material injury” to the domestic industry.

Last year, domestic kitchen cabinet producers unsuccessfully argued that certain wooden cabinets were covered under the AD/CVD orders on Hardwood Plywood from China that were issued in January 2018. Because DOC rejected their scope ruling request and ruled that certain wooden cabinets were not covered by the Hardwood Plywood AD/CVD orders, the domestic producers have filed these petitions to start new AD/CVD investigations to try to get new AD/CVD orders to cover Chinese wooden cabinets.

In 2018, the total U.S. imports of wooden cabinets from China was about $4 billion.

Scope

The proposed scope definition in the petition identifies the merchandise to be covered by this AD/CVD investigation as follows:

The merchandise subject to these investigations consists of wooden cabinets and vanities that are designed for permanent installation (including floor mounted,  wall mounted, ceiling hung or by attachment of plumbing), and wooden components thereof. Wooden cabinets and vanities and wooden components are made substantially of wood products, including solid wood and engineered wood products (including those made from wood particles, fibers, or other wooden materials such as plywood, strand board, block board, particle board, or fiberboard), or bamboo. Wooden cabinets and vanities consist of a cabinet box (which typically includes a top, bottom, sides, back, base blockers, ends/end panels, stretcher rails, toe kicks, and/or shelves) and may or may not include a frame, door, drawers and/or shelves. Subject merchandise includes wooden cabinets and vanities with or without wood veneers, wood, paper or  other overlays, or laminates, with or without non-wood components or trim such as metal, marble, glass, plastic, or other resins, whether or not surface finished or unfinished, and whether or not assembled or completed.

Wooden cabinets and vanities are covered by the investigation whether or not  they are imported attached to, or in conjunction with, faucets, metal plumbing, sinks and/or sink bowls, or countertops. If wooden cabinets or vanities are imported attached to, or in conjunction with, such merchandise, only the wooden cabinet or vanity is covered by the scope.

Subject merchandise includes the following wooden component parts of cabinets and vanities: (1) wooden cabinet and vanity frames (2) wooden cabinet and vanity boxes (which typically include a·top, bottom, sides, back, base blockers, ends/end panels, stretcher rails, toe kicks, and/or shelves), (3) wooden cabinet or vanity doors, (4) wooden cabinet or vanity drawers and drawer components (which typically include sides, backs, bottoms, and faces), (5) back panels and end  panels, (6) and desks, shelves, and tables that are attached to or incorporated in  the subject merchandise.

Subject merchandise includes all unassembled, assembled and/or “ready to assemble” (RTA) wooden cabinets and vanities, also commonly known as “flat packs,” except to the extent such merchandise is already covered by the scope of antidumping and countervailing duty orders on Hardwood Plywood from the People’s Republic of China. See Certain Hardwood Plywood Products from the People’s Republic of China, 83 Fed. Reg. 504 (Dep’t Commerce Jan. 4, 2018) (amended final deter. of sales at less than fair value, & antidumping duty order); Certain Hardwood Plywood Products from the People’s Republic of China, 83 Fed. Reg. 513 (Dep’t Commerce Jan. 4, 2018) (countervailing duty order). RTA wooden cabinets and vanities are defined as cabinets or vanities packaged so that at the time of importation they may include: (1) wooden components required to assemble a cabinet or vanity (including drawer faces and doors); and (2) parts (e.g., screws, washers, dowels, nails, handles, knobs, adhesive glues) required to assemble a cabinet or vanity. RTAs may enter the United States in one or in multiple packages.

Subject merchandise also includes wooden cabinets and vanities and in-scope components that have been further processed in a third country, including but not limited to one or more of the following: trimming, cutting, notching, punching, drilling, painting, staining, finishing, assembly, or any other processing that  would not otherwise remove the merchandise from the scope of the investigation if performed in the country of manufacture of the in-scope product.

Excluded from the scope of these investigations, if entered separate from a wooden cabinet or vanity are:

Aftermarket accessory items which may be added to or installed into an interior of a cabinet and which are not considered a structural or core component of a wooden cabinet or vanity. Aftermarket accessory items may be made of wood, metal, plastic, composite material, or a combination thereof that can be inserted into a cabinet and which are utilized in the function of organization/accessibility on the interior of a cabinet; and include:

Inserts or dividers which are placed into drawer boxes with the purpose of organizing or dividing the internal portion of the drawer into multiple areas for the purpose of containing smaller items such as cutlery, utensils, bathroom essentials, etc.

Round or oblong inserts that rotate internally in a cabinet for the purpose of accessibility to foodstuffs, dishware, general supplies, etc.

Carved wooden accessories including corbels and rosettes, which serve the primary purpose of decoration and personalization.

Non-wooden cabinet hardware components including metal hinges, brackets, catches, locks, drawer slides, fasteners (nails, screws, tacks, staples), handles, and knobs.

Also excluded from the scope of these investigations are:

All products covered by the scope of the antidumping duty order on Wooden Bedroom Furniture from the People’s Republic of China (Inv. No. A-570- 890). See Wooden Bedroom Furniture From the People’s Republic of China, 70 Fed. Reg. 329 (Dep’t Commerce Jan. 4, 2005) (notice of amended final deter. of sales at less than fair value & antidumping duty order).

All products covered by the scope of the antidumping and countervailing duty orders on Hardwood Plywood from the People’s Republic of China (Inv. No. A-570-051 and Inv. No. C-570-052). See Certain Hardwood Plywood Products from the People’s Republic of China, 83 Fed. Reg. 504 (Dep’t Commerce Jan. 4, 2018) (amended final deter. of sales at less than fair value, & antidumping duty order) (Certain Hardwood Plywood Products from the People’s Republic of China, 83 Fed. Reg. 513 (Dep’t Commerce Jan. 4, 2018) (countervailing duty order).

Imports of subject merchandise are classified under Harmonized Tariff Schedule of the United States (HTSUS) statistical numbers 9403.40.9060 and 9403.60.8081. The subject component parts of wooden cabinets and vanities may be entered into the United States under HTSUS statistical number 9403.90.7080. Although the HTSUS subheadings are provided for convenience and customs purposes, the written description of the scope of these investigations is dispositive.

Alleged AD Margins

Petitioner calculated estimated dumping margins for China that range from 175.50% to 259.99%, with an average margin of 216.04%.

Although Petitioner alleged numerous government subsidy programs that benefitted the Chinese wood cabinet industries, Petitioner did not allege a specific subsidy rates.

Named Exporters/ Producers

Petitioner included a list of companies it believes are producers and exporters of the subject merchandise.  See the producer and exporter list here.

Named U.S. Importers

Petitioner included a list of companies that it believes are U.S. importers of the subject merchandise.  See the named United States importers list here.

Estimated Investigation Schedule 

March 6, 2019 – Petitions filed

March 26, 2019 – DOC initiates investigation

Mar 27, 2019 – ITC Staff Conference

April 20, 2019 – ITC preliminary determination

August 3, 2019 – DOC CVD preliminary determination (assuming extended deadline)

October 2, 2019 – DOC AD preliminary determination (assuming extended deadline)

February 14, 2020 – DOC final determination (extended and AD/CVD aligned)

March 30, 2020 – ITC final determination (extended)

April 6, 2020 – DOC AD/CVD orders issued (extended)

For those of you who have not been keeping track, there has been an onset of trade actions brought by U.S. companies against incoming product from China. With all the trade issues involving China and bipartisan anti-China sentiment prevalent in the United States right now, the view is that now is a great time to bring such actions. This specific case was no surprise to U.S. trade lawyers and we fully expect (many?) more to drop in the next few months. If you are importing products from China, now is the time to know the trade risks of your imports.

China lawyersPotential clients often ask our China lawyers, “what’s the worst thing that can happen if I don’t do ________.” My usual response is I don’t know or you get sued or you get arrested or you will never be allowed to leave China.” See Doing Business in China with Deportation or Worse Hanging Over Your Head. Whenever I mention prison or getting stuck in China forever I can “hear” the eyes roll on the other end of the computer or the phone because few take this risk seriously.

Guess what people. Get over your First World rule of law biases and start dealing with the real world, or as a friend of mine who regularly deals with China hostage situations is always saying, “this is China.”

The “this” about China hit me hard today via our China Law Blog Facebook page (go here to check that out where, purely coincidentally, my most recent post is how the portion of my Chinese TV interview from yesterday where I discussed hostages in China was completely deleted). Anyway, here is today’s story and it is filled with absolutely critical lessons for anyone doing business in China AND for anyone doing business with China who has any intention of ever going to China.

So I wake up this morning with a Facebook message from someone in trouble in China asking us to publicize his situation on our blog to help in a fundraising campaign. The fundraising campaign is here and it is titled, Being wrongfully sued and not allowed to leave China and rather than have me tell the story, I will pull it word for word from this campaign (see below) and then “unpack” it. Just as an aside, I visited the Getty museum in Los Angeles about a week ago and our tour guide used that word (unpack) before analyzing each and every painting and sculpture. The first time she used it I loved it but by the tenth or so time I hated it. This being your first time….

In 2013/2014, we started a personal training fitness gym in Shenzhen, China with 3 foreign partners. The initial agreement and plan between the partners was to grow the gym, however 2 years into operation, due to a variety of factors beyond our control, we could no longer afford to operate the business at the standard that we wanted. We had to pay high costs and find a way to close the business while respecting the staff and community.

The attempted transfer and closing process took many months while we interviewed potential investors and people who wanted to take it over. It ultimately came down to a young Chinese man who had spent many months in the gym, wanted to own his own gym and was getting to know the operations and the members. Unfortunately for us, this man’s intentions were not honest, and he manipulated the situation to his favour. Since we are foreigners in China, we were not knowledgable about certain legal processes and trusted him in this transfer. He devised a way to take over the business by paying the business’s then upcoming bills due, and some debts owed – amounting to RMB 217,000 (approx US$ 32,000). He then wrote up a pre-agreed contract stating that the RMB217k was a loan and that the business and equipment would serve as collateral should the loan not be paid back. Since we wanted to simply move on from the business, and were not able to handle the expensive monthly overhead, we agreed to this process, meaning we received nothing in the end for a business we had spent 3 years building, but would be free of the business liability.

This Chinese man is a loan shark, and once we had parted ways with him, believing everything was agreed to and wrapped up, we moved on with our lives.

Fast-forward two years, and unbeknownst to us, this man had filed a lawsuit, claiming that the business owed him the RMB 217k. The case was filed, and was ruled in his favor, since we had no knowledge of the case and thus never showed up to court to contest this man’s false version of events. It wasn’t until John tried to leave the country that we came to find out about its conclusion as he was told that he would not be allowed to leave China. In China the legal system greatly favours Chinese, and the entire case was processed and closed without our knowledge and thus no response from us, and as it stands now we are being ordered to pay a whopping RMB 250k ($40K).

We want to chance to set the record straight and show the court the documentation which shows the agreement we had and how this man has committed fraud. We want to re-open the case, and respond to the verdict that was passed without our knowledge. In order to fight the case we need to hire a lawyer and pay court costs and so are asking our family, friends and any citizens of the world who can support our cause and pursuit for the truth.

Initially we are trying to raise RMB 55K ($8K) to cover the legal and court fees, so we can do everything possible to clear our good name and release the government hold on John’s passport. This will be a long, difficult battle but we will keep you updated every step of the way and maintain full transparency throughout this process.

Thank you so much for taking the time to read this, and for your support, whether financial or just by sending positive energy and thoughts our way.

Now for the legal unpacking (that’s only by second time with that word) and an analysis of what likely went wrong and what probably should be done to try to solve it. The quotes from above are in normal font and our analysis is in italics.

  1. “He then wrote up a pre-agreed contract stating that the RMB217k was a loan and that the business and equipment would serve as collateral should the loan not be paid back. Since we wanted to simply move on from the business, and were not able to handle the expensive monthly overhead, we agreed to this process, meaning we received nothing in the end for a business we had spent 3 years building, but would be free of the business liability.”  Mistakes: Not using a lawyer with this contract. Based on the above, it very much appears that this was a loan contract for RMB217k and this person(s) did not fully realize that. Any competent lawyer could have told them that. I am guessing the contract was in Chinese — why wouldn’t it be as it was a Chinese transaction —  and that may also explain why it was not fully understood. Or maybe it was a situation where eagerness took precedence over common sense. Who knows? Bottom line is that you should never sign a contract without fully understanding it and you should virtually never sign a contract without the assistance of a qualified lawyer.
  2. Fast-forward two years, and unbeknownst to us, this man had filed a lawsuit, claiming that the business owed him the RMB 217k. The case was filed, and was ruled in his favor, since we had no knowledge of the case and thus never showed up to court to contest this man’s false version of events. Mistakes: Maybe none, or maybe this person received notice of the lawsuit but did not realize what it was. I say this because Chinese courts tend to be very good at getting their notices out and they also tend not to rule until it has been confirmed that notice was received.
  3. It wasn’t until John tried to leave the country that we came to find out about its conclusion as he was told that he would not be allowed to leave China. Mistakes: Chinese law allows the government to not allow people to leave who owe money. This is why our China lawyers are constantly telling people not to go to China if they MIGHT owe money and to get the hell out of China as quickly as possible if they are there. See Maybe Owe Money To China? Don’t Go There. 
  4. In China the legal system greatly favours Chinese, and the entire case was processed and closed without our knowledge and thus no response from us, and as it stands now we are being ordered to pay a whopping RMB 250k ($40K). Mistakes: I’m guessing a Chinese defendant would have had the same result as it sounds like a fairly garden variety loan agreement and this amount probably included interest and perhaps attorneys’ fees as well.
  5. We want to chance to set the record straight and show the court the documentation which shows the agreement we had and how this man has committed fraud. We want to re-open the case, and respond to the verdict that was passed without our knowledge. In order to fight the case we need to hire a lawyer and pay court costs and so are asking our family, friends and any citizens of the world who can support our cause and pursuit for the truth. Mistakes: Is it even possible to re-open the case at this point? I do not know but I doubt that it is. I could be wrong about this, but it seems to me that this person is doubling down on his mistakes by again not hiring a lawyer to figure out the best way to get out of this. Let’s just suppose it is not to late to try to “re-open” the case. In most countries of which I am aware, to be able to re-open a case like this you must not only show that you were not given notice of the case you also must show that if the case were to be re-opened that you have at least some chance of overturning the ruling on the merits. If this is a legal and valid and garden variety loan agreement, that chance may very well not be there. If re-opening the case is going to be impossible, no money should be spent on that route. It probably should instead be spent on trying to strike a deal with the lender and in return for whatever payment he accepts, a settlement agreement is signed (this settlement agreement should be in Chinese and pursuant to Chinese law) and then used to get the hold on leaving China lifted. 

But in the end, this person does need money to hire a Chinese lawyer (probably ideally based in whatever city in which the lawsuit was brought) to figure out how to figure out the situation and help this person get out of China.

International manufacturing contracts lawyers

In Part 1 of this series, we talked about how the product development stage is the highest risk stage for foreign companies manufacturing overseas and yet also the most neglected stage. In Part 2, we talked about how foreign companies often will use NNN agreements in the factory search stage and Manufacturing Agreements (ODM, CM and OEM) for the production stage, but rarely use Product Development Agreements during the product development phase because they often fail to recognize they are in that stage or because they believe their NNN Agreement will protect them. We then explained why this can be a big mistake, the results we often see from this “big mistake” and, most importantly, how to avoid it.

In this Part 3, I am going to make a slight diversion based on an email exchange I have been having with a European company that started with it wanting our international manufacturing lawyers to review an NNN Agreement and a Mold Ownership Agreement it had paid a Chinese law firm to draft. This company was having a “bad feeling” about the documents and wanted our manufacturing lawyers to make sure they “would work for China” before submitting them to its longstanding Chinese manufacturer, with which it had maintained a “superb” relationship for the last seven years. I very quickly looked at the contracts — they were probably passable — but immediately wrote back to the company to ask whether it had a Manufacturing Agreement with this Chinese manufacturer. The response from the Spanish company was essentially, “no, but why.”

The why is that a Manufacturing Agreement is exactly what this company needed and it could have saved time and money and even credibility with its Chinese manufacturer by getting it. I explained that due to the stage it was in with its Chinese manufacturer, it would have been faster, cheaper and way way better for it to have had its Chinese law firm draft a Manufacturing Agreement with its Chinese manufacturer that included a paragraph with NNN provisions and another paragraph simply making clear that the Spanish company owned the listed molds.

That very recently concluded email exchange got me to thinking of how incredibly common it is for companies to come to us after having spent good money for legal things they either did not need at all or barely needed, especially in comparison to what they truly did need. We see this sort of overbuying/overselling all the time. Just last week, I consulted with a company that came to us after having paid for four trademarks in China when due to its situation it clearly only needed one and another company that had paid for a China employment contract even though it had no Chinese entity, which is one of the most dangerous things any foreign company can do. See American Companies in China without a WFOE and the Impact of Donald Trump and US Tariffs and Why Hong Kong is not the Answer.

Pretty much every day, a client or a potential client will come to one of the attorneys at my firm — and this holds true for every area of law in which we practice, not just international law — saying that it wants to retain us for X when the client actually needs Y. Needless to say, our attorney never would say, “sure, I will charge you for Y and do Y” while all the while thinking “this client really needs X.” No. She would say, “wait a second,” what you need here is not Y, but X, and let me explain why this is the case. Unfortunately, Chinese lawyers — certainly NOT ALL Chinese lawyers have been trained differently and I talked about this in an interview I gave back in 2016 (See On Being a China Lawyer and on Doing Business In China: An Interview):

Dan: I’ll backtrack a little and tell you the problems American companies often have with Chinese lawyers.

An American company will hire a Chinese lawyer and tell the Chinese lawyer, “I want to do ‘A,’” and the Chinese lawyer will do “A.”

Three months later the American company will learn that no one’s doing “A” anymore. They’re all doing “B.” So it will go back to the Chinese lawyer and say, “Look, we did ‘A.’ Now everyone’s telling me that wasn’t a good idea.” The Chinese lawyer will then say, “Right, it was not a good idea.”

“Then why did we do ‘A’?”

“Because you told me to do ‘A.’”

It drives American companies nuts. If you had called up an American lawyer, he or she would have said, “Why do you want to do ‘A’? We do ‘B’ 99% of the time. Let’s talk about it.” When somebody tells me they want to do something, I don’t just say, “Yes.” I ask them 10 questions because I want to make sure that’s the right way to go.

The typical dynamic between Chinese companies and Chinese lawyers is, “I’m the boss. You’re my scrivener.”

One time we were brought in to help a Chinese company. Twenty years ago it had formed an American company, and then that American company had formed a Chinese company. It’s called a “roundtripper.” China once gave all sorts of preferences to foreign companies; Chinese nationals would form American companies, then go back to China to get the preferences. Not legal, but it was very common.

This Chinese company had gotten huge. They had a company in the United States that was formed by somebody’s cousin, had never paid taxes, and maybe had aspirations of going public. They needed to clean up their act. It was hugely complicated, and we brought in an international accounting firm to help on the tax side.

My colleague Steve Dickinson is based in China, and one of the lawyers we work with there invites him out to lunch. Steve is thinking, “That’s weird. This lawyer never invites me to lunch.” Steve goes to the lunch and the client is there, and the client has this idea on how to solve the problem in about 1/10 the time and at about 1/100 the cost of what we have said needs to be done.

Steve tells the client (nicely, I presume), “Are you kidding me? You know nothing about U.S. laws, you know nothing about U.S. taxes, you’re not a lawyer or an accountant in China, and you think you’ve just solved the problem? Give me a break.” Why was Steve brought to this lunch? Because the Chinese lawyer knew it was absurd, but he just was not comfortable telling this to his client because that is not his role.

When Chinese companies come over here to the United States, they often want to tell us exactly what to do. Once we took on a case where as soon as we were paid, the Chinese company told us how we were going to handle it. We told them that what they were asking us to do would be the dumbest thing we could possibly do. (I talked with about 10 other lawyers and they were like, “Seriously?”)

“No, we need you to do that,” the Chinese company said.

We responded, “Nope. Here’s your money back.”

As American lawyers, we can’t have that. Our reputations are on the line. We’re not going to do something that makes us look silly and just wastes the client’s time and money. We’ll do things for clients even if we disagree, but not when it’s absurd or unethical.

What does all of the above have to do with saving your shirt when manufacturing overseas? A ton. Because one of the ways you save your shirt is by getting all of the manufacturing contracts and protections you need and no more.

The below is a typical email I send in response to a company that writes saying that they need legal help with their overseas manufacturing and asking how we would propose to provide them with that help.

Working with our international manufacturing lawyers will in the end always depend on what makes sense for your company and your product, but to give you at least some idea of what we do, I can tell you that we usually do some combination of the following for our clients that are looking to have their products manufactured overseas:

NNN/NDA Agreements. We almost always do these in the language of the country of your manufacturer (the official version) and in English (for you) and they typically take us 4-5 business days to complete. You can learn more about our NNN Agreements here. We draft our NNN Agreements to protect confidentiality and to prevent your overseas manufacturer from competing with you or circumventing you. They make sense before you reveal any confidences. If you choose to have us draft an NNN Agreement, we first send you (via DocuSign) a one page Flat Fee Agreement setting out the fee structure. We next send you a questionnaire and when we have your answers to that we draft the NNN in English for your approval. Once you approve of the English language version, one of our lawyers will translate that into the official language and we then send that to you. You then send the full NNN Agreement to your overseas counter-party and if it proposes any changes we will revise it.

Manufacturing Agreements. Once you have chosen your overseas manufacturer, you need a Manufacturing Agreement (a/k/a OEM Agreement or Product Supply Agreement) in the language of the country of your overseas manufacturer (official) and in English (for you). These typically take us 10-14 days to complete. You can find out more about our Manufacturing Agreements here. Our drafting process for these agreements is similar to our drafting process for our NNN Agreements. If you are already certain who you will be using as your overseas manufacturer you can probably skip the NNN Agreement and go straight to the Manufacturing Agreement as our Manufacturing Agreements contain all the substantive provisions of our NNN Agreements.

Trademarks. If you plan to put your company name or your brand name or your product name or your logo on your product or on its packaging, you need to register those as trademarks in the country in which you will be having your product made (there are some exceptions to this which we can discuss when you are clearer on where you will be doing your manufacturing). This is usually true even if you will not be selling your product in the country where your products will be made. Our trademark fees vary by the country. It also generally makes sense for you to have a trademark in those countries in which you have or expect to have substantial sales and we can help you with that also. It also sometimes makes sense to secure patents or trademarks as well.

In addition to the above (each of which depends on your situation and/or your product) and depending on how your production progresses, there may be other agreements necessary. If you want help finding the right factory, we can help with that also, either with our own people (for Vietnam or Thailand) or by referring you to outside sourcing experts.

Our goal is to provide our clients with customized solutions to fit their manufacturing needs. Towards that end, if you have any additional questions, please do not hesitate. In the meantime, if you can tell us more about your product, your situation, and your goals, we can help narrow down your actual needs. At some point I would be happy to get on the phone with you because in 10-15 minutes of my peppering you with questions I am confident I can figure out exactly what you need and if I can’t, I can refer you to one of our more specialized lawyers who can.

Bottom Line: When manufacturing overseas, what makes sense for you is what makes sense for YOU and that is not usually going to be what you read on the internet nor what some other company tells you it did nor what you tell some law firm you need nor what some law firm wants to sell you.

Your thoughts?

International lawyers for manufacturing contracts

In Part 1 of this series, we talked about how the product development stage is the highest risk stage for foreign companies manufacturing overseas and yet also the most neglected stage. Foreign companies will use NNN agreements in the factory search stage and Manufacturing Agreements (ODM, CM and OEM) for the production stage, but they rarely use Product Development Agreements during the product development phase, oftentimes because they do not recognize they are in that stage or because they believe their NNN Agreement will protect them. This is a big mistake that often leads to one of two disasters for the foreign company.

The failure to use a product development agreement often leads to one of two disasters for the foreign company.

The first disaster usually occurs when the overseas manufacturer does the product development work at no charge. In these situations, the overseas manufacturer often will claim the intellectual property rights in the developed product are its own and will “generously” offer to manufacture the product for the foreign company at the price, payment, quantity, quality and delivery terms chosen by the overseas manufacturer. No matter how outrageous the pricing or other demands from your overseas manufacturer, there is little you can do because you waited until development was finished before even considering who would end up with “your” IP and now your overseas manufacturer owns it all. Our international manufacturing lawyers see this all the time, especially with start-up companies involved in making products for the Internet of Things ecosystem. See The Internet of Things: Do You Really Own “Your” IoT Product?

The second disaster stems from foreign companies not considering the procedural/operational issues inherent in successfully developing a product. Foreign companies far often mistakenly assume their overseas manufacturers can develop any product within the tight timeframes and close tolerances required by modern business. This often leads to the following problems:

  • The product is never completed or never works properly.
  • The product is not completed until after the market opportunity has passed.
  • The product ends up costing far more than anticipated.

And again, Internet of Things companies seem particularly prone to this.

The best way to address the above product development risks is with a product specific product development agreement tailored to the country in which your manufacturer is located. A good product development agreement covers the period between the NNN agreement stage when you are figuring out which manufacturer to use and the Manufacturing Agreement stage when you have already selected your manufacturer and know exactly what you will have manufactured.

A good product development agreement generally includes provisions addressing the following:

1. The product to be developed.

2. The specific technology the foreign company and the overseas manufacturer will contribute.

3. Who will provide product specifications and in what form.

4. Who will own the IP rights to the resulting product. Our international manufacturing attorneys often review overseas product development projects where the overseas manufacturer has asserted it owns all of IP rights in the developed product. These overseas manufacturers typically had agreed to make “their” product available to our clients  while at the same time manufacturing the product for their own sales under their own trademark and for sales to competitors of our client. Our clients are usually stunned when we tell them that because they had no written agreement making clear they would own the resulting product and the resulting IP in that product, their overseas manufacturers are legally justified in claiming IP ownership because they contributed their technology to developing the product and because they incurred the product development costs.

5. Who will pay for product development costs?

6. Who will pay for the molds and tooling? This becomes a major issue when the foreign company seeks to use a different manufacturer after product development is complete. In this situation, the overseas manufacturer that helped you to develop the product will likely do one of the following:

a. Refuse to release the molds, tooling, CAD drawings and other items required to manufacture the product.

b. Require you pay a substantial fee to give you the molds, tooling, CAD drawings and other items related to the product.

c. Claim ownership in the IP related to the product and threaten to sue you in its own country if anyone else manufactures the product.

You will be particularly badly positioned if your overseas manufacturer did the development work and produced the molds and tooling at its own cost, though it is also very common for overseas manufacturers to engage in the above tactics even when you paid for the molds and tooling. You are not going to be protected from this unless you have a written agreement (enforceable in your manufacturer’s country) making clear you own the molds and tooling and penalizing the overseas manufacturer for not immediately returning those to you. See Product Molds And Tooling Three Things You Must Do to Hang on to Yours.

7. Setting milestones. Overseas manufacturers will often agree to do your development work but then fail to do so in a timely manner. Your product development agreement should provide incentives for your overseas manufacturer to meet the listed milestones and a penalty if it does not. The following is a typical arrangement:

a. The overseas manufacturer does product development at its own cost and you pay all hard costs for molds and similar items.

b. Milestones and clear specifications for product development are set.

d. You and your overseas manufacturer agree on a target price and quantity for when the product is developed.

e. If your overseas manufacturer meets the milestones and specs and agrees to sell at the target price and quantity, you will then enter into a Manufacturing Agreement with it.

Overseas manufacturers (especially in China and especially in Chinese-owned factories in Vietnam and Thailand) usually prefer to cover all product development costs because they want to own the resulting product and foreign companies far too often go along with this, without realizing this likely means your overseas manufacturer will end up with “your” product and its related IP.

In part 3 of this series we will discuss how to protect your molds and tooling when manufacturing overseas.

Asia product development contracts

When a company comes to us looking to have its product outsourced for manufacturing in a foreign country, they often do not have a fully final product. By this I mean that their “product” can be anything ranging from a mere idea to a prototype needing further development before large scale manufacturing to a product needing minor refinements to a fully-fledged ready-to-go product. Our international manufacturing lawyers deal with less than fully-fledged products more than half the time.

Often, a client will believe its product is “ready to go” when it actually can (and should be) further modified to reduce production costs or simply to make it just a little bit better. It is quite common for good overseas manufacturers to suggest at least a few helpful changes to so-called final products.

Whenever an overseas manufacturer modifies (even slightly) one of our client’s products (and even when they don’t), we as lawyers immediately have the following three questions:

  1. Will our client own the IP rights to the modifications?
  2. Will our client own the IP rights to the final product?
  3. How can we as the lawyers best protect our client’s IP rights in the modifications and the products?

These are not merely academic questions either as our international IP lawyers get a fairly steady stream of American (United States, Canada, Brazil and Mexico, mostly), Australian,  and European companies seeking help to “recover” their IP rights taken by their (mostly) Asian manufacturers. Much of the time there is little our IP lawyers can do in these situations either because it is not clear who owns the IP rights or it is clear that our client unintentionally relinquished the IP rights to its manufacturer. Even worse, there are plenty of times where we have to tell our client that it is not clear who would prevail were we to bring a lawsuit but it is very clear that such a lawsuit will be incredibly time-consuming and expensive and require all sorts of highly paid experts.

Who owns the IP rights in your product? Do you really know? It is not uncommon for manufacturers to wait years before asserting their rights to “your” product. This assertion usually comes when your manufacturer decides the time has become right for it to begin selling its own products or when you decide you want to use another manufacturer. See Your China Factory as your Toughest Competitor and How to Stop Your China Manufacturer from Selling Your Product to Others: Don’t Let This Happen to You for how common the first of these scenarios has become and see Why Changing Suppliers Can Be So Risky for how incredibly common the second of these scenarios has always been.

The product development stage is the highest risk stage for foreign companies manufacturing overseas and yet also the most neglected stage. Foreign companies will use NNN agreements in the factory search stage and Manufacturing Agreements (ODM, CM and OEM) for the production stage, but they rarely use Product Development Agreements during the product development phase, oftentimes because they do not recognize they are in that stage or because they believe their NNN Agreement will protect them. This is a big mistake that often leads to one of two disasters for the foreign company.

In part 2 of this series we will set out why not having a timely and country-specific Product Development Agreement can a mistake, the two disasters our international lawyers often see that arise from this mistake and, most importantly, what you can do to prevent all this.

Stay tuned….

China Manufacturing Contract lawyers

Just read a great post on China ODM manufacturing at the always super-helpful Quality Inspection Blog. The post is entitled The Danger of Developing your Custom Product with an ODM Factory and it is on how going to an ODM factory for a custom product is both a sourcing and a legal mistake.

The post notes how foreign companies looking to have a custom product made in China are “tempted to go for a shortcut: working with a manufacturer that has been making very similar products (an Original Design Manufacturer, or ODM)” and on why that is so often a really bad idea. Per the post, the pros for using an ODM manufacturer to make your custom product are speed and starting costs, both because the ODM manufacturer is already making something close to what you want for your custom product. The cons are the following:

  • Changing your supplier will be difficult because it owns the design.
  • You are taking a risk because your supplier may have stolen its design from another company and your product may get sued for IP infringement and banned from key online marketplaces.
  • If your sales are high your supplier will tempted to compete with you.
  • You will have a tough time getting favorable terms.
  • Your design improvements/innovations will “feed” your supplier to be better able to compete with you.

The post then comments on how common it is for the Chinese ODM factory to get valuable design input from the foreign buyer and then go off and make the product for themselves. To help avoid this the post recommends getting the Chinese ODM factory to sign an enforceable non-disclosure, non-use, and non-circumvention agreement.

The above is all true and it leads the author to conclude that if you are going to have large quantities of your product made, you are better off using a contract manufacturer, not an ODM manufacturer.

From a legal perspective I cannot resist making one more suggestion. If you are working with any sort of manufacturer in China (or Vietnam or Thailand or Taiwan or Turkey or Spain or anywhere else) on together developing a product, you should have a Product Development Agreement with that manufacturer that is clear on who does what, who pays for what and, most importantly, who will own what in the end. And that contract must be written with your specific goals and product and country of manufacture in mind. In other words, a Product Development Agreement written for Spain is not going to work in China and a Product Development Agreement written for China is not going to work in Vietnam.

For more on how to protect yourself when manufacturing overseas, check out Overseas Manufacturing Contracts (OEM, CM and ODM).

Oh, and one more thing I feel I must drill home. As a result of the US-China trade war and the rapidly declining economic state of so many Chinese factories our China manufacturing lawyers are seeing more IP theft and more quality problems early from Chinese factories than we have in at least a decade. Along these same lines, check out China Trademark Theft. It’s Baaaaaack in a Big Way.

Be careful out there. More than ever!

China lawyers
Because of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments or phone calls as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a quick general answer and, when it is easy to do so, a link or two to a blog post that provides some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.

One of our China employment lawyers sent me an email from the head of HR (based in the United States) of a potential client regarding an employer audit. In these audits our China employment lawyers start by reviewing all of the client’s employment documents, mostly consisting of their various contracts with their employees. After our employment lawyer explained the basics of what we do in our employer audits, the potential client mumbled — to the extent you can mumble in an email — how, “in the end, does any of this really make sense when everyone knows employees in China always win.”

That’s actually a good question because in employee-employer lawsuits the employee does pretty much always win. See China Employment Arbitration: Good Luck With That Battle. So why even bother?

China lawyers

A China lawyer I know was asked by a reporter whether business relationships between the United States and China will return to normal if a trade deal is reached. His response was as follows (per an email):

No deal between China and the US will cause everyone on both sides to say, “we were just kidding.” The tariffs and the arrests and the threats and the heightened risk have impacted companies and those things are not going to be forgotten. Many companies that could quickly reduce their dependence on China have done so or are continuing to put things in place to do so, no matter what happens on the trade deal. Many are being open about wanting to get out of China as fast as possible no matter what.

Many Americans living and working in China say they feel “hated” there and that makes them very uncomfortable. Many Canadian companies (and American companies as well, but to a lesser extent) have curtailed their travels to China out of sheer (and justified) fear. This will undoubtedly lead to many of them curtailing their China business as well. People are seeing China for what it really is and they don’t like it and they want out. Add in the fact that wages and costs in China just keep rising and you are essentially have the perfect storm for foreign companies to leave China or at least reduce their presence there.

The China lawyers at my firm are hearing the same sort of things. More importantly, we are being tasked with helping our clients reduce or eliminate their presence in China and then working with them on the legal side of doing business with other countries. What countries? So far we are seeing/hearing the following:

1. Thailand is very much open for business.

2. Vietnam is very much open for business, but it has become so “busy” on so many fronts that lead times can be quite slow.

3. Mexico is very much open for business. Some companies refuse even to consider Mexico because of security fears. We see this as a huge mistake because there are plenty of great areas in Mexico that are shockingly safe.

4. The Philippines is very much open for business and we have been shocked at the breadth and depth of the manufacturing there.

5. Malaysia is very much open for business.

6. Taiwan. We have seen many companies that used to be in Taiwan return to Taiwan. Taiwan is a very easy country in which to do business, but it does tend to be more expensive than China.

7. Turkey. I am hearing of a few companies looking at Turkey. I find this very interesting because I did a year of foreign study there and learned Turkish and I have friends from that time who are lawyers there.

8. India, Bangladesh, Pakistan, Cambodia, and Sri Lanka.  Mostly clothing, at least so far.

9. Poland, Portugal and Spain. We see a lot of Spain interest because we have lawyers there, but very little of that is related to China. We are seeing nascent interest in Poland and Portugal, especially for tech (software).

But China is not going to “just go away.” No way. It’s not going to become “an even larger, more powerful North Korea,” as I have heard some threaten will happen if the United States and the EU were to hang tough against China. No way. What I see is American (and European and Australian companies better recognizing what it is like to do business with China or in China. The days of so many companies having stars in their eyes about China are over and this newfound realism can only be a good thing. Will American and European and Australian companies continue to do business with China? Absolutely yes, but in lower numbers than previously. How much lower? Hard to say, but I would anticipate seeing a steady decline (maybe totally around 30%) over the next five years. China will remain a big and important country and that should not be discounted. But the big change we are seeing and expect to see accelerate is foreign companies that would in the past just check the China box are now exploring other countries as well. And this too can only be a good thing.

What are you seeing out there? No really, please tell us in the comments below. 

China WFOE formation lawyers

One of the first tasks in forming a WFOE in China is to determine what entity will be the shareholder of the WFOE. It is possible for an individual or individuals to own a China WFOE, but for various reasons, our China WFOE formation lawyers nearly always discourage that.

The basic analysis runs as follows:

1. Direct ownership of a WFOE by the foreign operating company parent company is most common for single owner WFOEs.

2. For clients that either do not want their company to be easily identified with the WFOE or for various other reasons do not want their company to own the WFOE, forming or using a Special Purpose Vehicle (SPV) — a separate holding company not directly linked to the main company — is possible.

When considering an SPV for owning a China WFOE, the following considerations can be important:

a. Over the past decade, the Chinese government has become suspicious of SPVs. At one point, it even moved to prohibit SPVs for WFOE formations. However, with the adoption of the new WFOE formation rules in 2017, the Chinese government now permits using SPVs. So current Chinese government rules are neutral on this issue.

b. In the past, one reason investors used an SPV was to hide the true identity of the owners of the WFOE. Under China’s new WFOE formation rules, the investor must provide a complete organizational chart that details ownership of the shareholder(s) and that identifies the actual controlling person. It it therefore impossible to conceal ownership. Accordingly, SPVs are no longer useful to conceal actual ownership from the Chinese government.

c. SPVs continue to be used where there are several investors in the WFOE. Often these investors are resident in different jurisdictions. In that case, it is common to take all these investors into a single SPV. The SPV is then the single shareholder of the WFOE. Issues such as management, distribution of profits and purchase and sale of ownership interests are handled at the SPV level. In many cases, the SPV is formed in a tax haven such as Hong Kong to allow distribution of profits free of tax. These considerations do not apply in a single shareholder setting.

d. In terms of limiting upstream shareholder liability, there is little to no benefit in using an SPV. The WFOE will be a limited liability legal entity. The limitation of liability rules apply in China in somewhat the same way as in the United States, Australia, Canada and the EU (including the UK). The financial liability of the WFOE is limited to the amount of investment. Liability beyond the investment amount generally occurs only in the case of illegal acts. In China this liability would generally be as follows:

  • The shareholder will be held liable if it does not contribute required capital to the China WFOE and that failure results in the WFOE not paying its taxes, employee salaries, or in a fraud against creditors.
  • A WFOE’s director will be liable for instructing the WFOE to commit an illegal act. Examples of illegal acts are tax fraud or commission of a significant safety violation.
  • Directors and the shareholder will be liable if the WFOE terminates business and does not liquidate pursuant to Chinese company law. An improper WFOE shutdown leads to both the investors and the directors being placed on a black list and prohibited from engaging in other investments or business in China. Individual directors should not travel to China since they may be detained. See Shutting Down a China WFOE: Don’t Go There.

The above three basis for liability are all very real, but creating an SPV does not noticeably reduce any of these risks. This is because most of the liability risk falls on the individual directors, not on the shareholder. Second, the Chinese government will use the org chart/actual controlling person information to “pierce the corporate veil” to assign liability to what the Chinese government determines in its own discretion is/are the actual party/parties in interest.

Other basis for liability arising from WFOE operations are so rare that they can in most instances be discounted. On the other hand, the three basis for liability set forth above are common and care must be taken to avoid these sorts of liability situations.

3. There are sometimes tax or other operational or accounting reasons for create an SPV for China WFOE ownership. In considering whether to do an SPV, a cost-benefit analysis makes sense. Most of our clients find using an SPV to own their China WFOE more trouble than it is worth. However, each situation is different and there are definitely times where SPV ownership of a China WFOE makes good sense.