Exclusive Manufacturing Agreements
Going through old emails and found an email from one of our international manufacturing lawyers to a client that needed help drafting up a term sheet for one of its suppliers that had agreed to grant it an exclusive on various products. I have modified the email slightly to remove any potential identifiers and I run it below. I am running this email because it nicely sets out some of the more common issues that arise with exclusive purchasing agreements. We are big fans of terms sheets because they quickly and cheaply can reveal whether it makes sense to move forward with drafting a contract or not.
I will be working on your term sheet. I have reviewed your outline statement of what you want and I have the following initial questions:

1. Key Business Issues. Your outline does not mention various key business issues, such as price, quantity, delivery date, product quality. Do you want to leave that out in this term sheet? If yes, then we will state that all of the business issues would be resolved in a separate contract manufacturing agreement between the parties.
Note that it is normally not possible to address these issues later. On this issue please note the following two issues have consistently arisen in other exclusivity agreements that we have done:
a. The factory virtually always refuses to agree to exclusivity without an agreement on price and quantity. The factories generally want a fixed price and a fixed minimum sales quantity for each year of the agreement and a provision stating that a failure to achieve these minimum sales amounts at the agreed price terminates the exclusivity provision. Where exclusivity cuts the factory out of key markets like North America and Europe, many factories also will require payment of a substantial amount in advance, payment of the remaining amount on a fixed schedule, and a premium price.
b. Once the amounts at a. have been paid, factories tend to slack off on both QC and on-time delivery. They see this as part of your “price” for exclusivity.
We can deal with the slacking issue with the Manufacturing Agreement. The issues at 1. a. normally should be confronted as an integral part of the exclusivity agreement.
Please advise how you wish to proceed. You may decide to defer the price/quantity issue until after you have reached agreement on the basic exclusivity issue. If you decide to go that way, we will draft accordingly.
2. Contract Term. You mention wanting a five year term, but what will be the rule for renewal? Normally, the renewal rule is that if you reach the sales minimum in the first term, you have the absolute right to renew for an additional 5 year term. You could, however, provide that you have the right to renew entirely at your discretion. Please advise on how you wish to proceed on this issue.
3. Territory. You have provided several different descriptions of what will be your exclusive territory. For this type of agreement, it is necessary the initial territory be stated with specificity. If you will have the option to expand the territory during the term, then we must state the rules for adding new territories. For now, we can provide for a clear initial territory and then state that you have the right to add additional countries to that territory by notice to the factory. The only restriction will be that the factory is not selling into that territory. Note that most factories will want to increase the minimum sales amount upon each expansion of territory.
4. Exclusive product. The basic method is the following:
a. The factory product is base product.
b. The product modified for your use is the custom product. The custom product includes product with your logo/trademark and any modifications made exclusively for you.
Rules:
a. The factory cannot sell custom product anywhere in the world.
b. The factory’s base product is subject to the exclusivity rules noted above. That is, the factory is not permitted to sell the base product into the exclusive territory during the exclusivity period.
For this system to work, a very clear definition of what constitutes the base product is required. This can be based on current models made by the factory or by a general description of the product covered. You will need to provide us with the appropriate description.
5. Expansion of base product/exclusive product. You will have the right to treat new products from the factory as base products, subject to modification into custom product and subject to treatment as exclusive product.
You will need to clarify this provision. If base product is defined with a general description, any new product that fits that description is automatically covered and is automatically treated as exclusive product. So this provision would only be required if the new product is a product that does NOT fit into the definition of base product.
Please advise on what you intend for this provision.
6. Advertising. You mention your factory currently advertises on various online marketplaces and so you want them to send you any North American, Latin American and European inquiries they get.
​I assume you mean if they receive an enquiry concerning the factory base product from a customer in the exclusive territory, the factory will not sell to that customer, but instead forward the enquiry to you. As discussed at 7. below, this assumes the factory will not be permitted to advertise your custom products on any factory website or on any e-sales platform anywhere in the world. Normally we require the factory state the limitations on their sales territory in any Internet or other advertising.
7. You stated that you will establish and enforce the criteria regarding which dealers are deemed “acceptable” to sell your brand.
But remember that you will be the exclusive seller of your products in the territory; the factory will have not have any right to sell your products to anyone but you. The factory will not have the right to sell any base products into the territory. For these reasons, it appears this provision is not required. Please advise.
Please advise on the above. After we clarify the terms, I will draft the term sheet. If you have questions or need clarification on issues raised, please let me know.
China employment contracts
Don’t waste your money with an English language employment contract

Our China lawyers sometimes get “simple” questions from our WFOE clients regarding China’s labor law. One such question is whether they must use Chinese as the prevailing language for their employment contracts with their employees, especially with their expat employees. This question is not as simple as it may first appear.

First off, there is little national guidance on this other than an “ancient” 1995 document with the long title of Letter of the General Office of the Ministry of Labor on Implementation of the Regulation on the Labor Administration of Enterprises with Foreign Investment (the “Letter”). The Letter explicitly requires the language of a China employment contract be in Chinese. However, the authority of this document is questionable because its underlying regulation is no longer in effect, having been replaced in 2007 by the PRC Labor Law and other relevant laws and regulations. So just as is the case with so much of employment law in China, it is important to look into how each locale deals with this issue.

In Shanghai, you must have a Chinese version for your labor contract. Though you may have an English language translation of your contract, Chinese must be the controlling language. Shanghai (more so than many other Chinese cities) generally takes a liberal view on freedom of contract and when it comes to employment contracts between Shanghai employers and their expat employees, Shanghai generally will respect the parties’ own arrangement so long as those terms do not contradict matters covered in the relevant laws. Notwithstanding Shanghai’s general approach, if there is a conflict between a Chinese language employment contract and an English language version, the Chinese version will control.

Similarly, Jiangsu Province explicitly states in its provincial Labor Contract Regulations that in the event of a dispute involving an employment contract written in a foreign language and in Chinese, the Chinese language will prevail.

What happens in legal disputes where the employment contract is in just English? The courts will sometimes have the contract translated but other times, they will simply rule there is no valid employment contract and penalize the employer accordingly.

We recommend inserting a provision in your employment contracts making it clear the Chinese language controls. We make this recommendation because the Chinese language version almost certainly will be the one that applies anyway, but also because this lets everyone know exactly what will happen if there is any dispute regarding the applicable language — which disputes happen more often than you would think. It is seldom a good idea to set yourself up for having to pay attorneys to fight about the applicable language.

We virtually always write our clients’ employment contracts in both English and Chinese, even though the Chinese will control. We do this because it is critical our clients fully understand their employment contracts (same for the company rules and regulations relating to their employees) so they can be sure to abide by them. Employer-employee disputes are incredibly common in China, particularly for foreign companies doing business in China. Having clearly written employment contracts in both Chinese and in English reduces the number of those disputes and their cost should one arise.

China hong kong wages As China steps up its tax enforcement against both foreign companies and foreigners, we are seeing increasing instances where expat employees working in China are having their salaries “split” by their Chinese or foreign company employers. We strongly counsel our employer clients against doing this sort of salary splitting and we even more strongly counsel against expat employees accepting such splitting. For one very simple reason: it is illegal and it puts you at great risk.

China employer taxes and benefits are steep. Roughly speaking, for every 100 Yuan an employee in China gets paid, the employer pays out an additional 40 or so Yuan in employer taxes and benefits. In other words, about 40 percent. And for every 100 Yuan a China-based employee gets paid, the employer is supposed to withhold around 25 Yuan for employee taxes. In other words, about 25 percent. So imagine the savings if instead of paying an employee $100,000 on the China tax and benefit grid, you instead pay just $30,000. How though can a China employer achieve this savings while still paying its employees at market rate? I mean you cannot just pay a top tier foreign software engineer $30,000, or can you?

You can if you are willing to violate Chinese law by engaging in tax fraud. This is most commonly done by splitting the salary by paying the employee $30,000 in China and $70,000 via Hong Kong or the United States or wherever. Ten years ago — before China became considerably more sophisticated with its tax system and its ability to root out tax cheats, foreign SMES with employees in China (especially expat employees) would engage in this sort of salary splitting. You might have a company in Houston that would send an employee to China and have its WFOE in China pay that employee $30,000 in China while sending $70,000 each year from the US company to the employee’s US bank account.

China now employs various techniques to crack down on this sort of thing and in response to that it has become way less common to see a foreign company engage in such fee splitting. One of its best and easiest techniques is to simply call bullshit on the idea of a company being able to pay a top-tier expat software engineer $30,000 a year. The other is to offer a tax amnesty to your just- terminated employee to get him or her to report your tax fraud. Then armed with that, China will not so politely demand you immediately pay it all past taxes and benefits, plus interest, plus massive penalties.

But though foreign companies are for the most part ending illegal salary splitting, Chinese companies have been taking it up with somewhat of a vengeance. Ten years ago, it was rare for an expat to work for a Chinese company in China, but today that is commonplace. But it is also commonplace for Chinese companies to be unhappy/reluctant about high expat salaries and having to pay full taxes and benefits on that. This has led our China employment lawyers to now see a slew of expat employees being offered $100,000 with $70,000 paid to them through Hong Kong.

This has also led Chinese companies to come up with some very creative justifications for their illegal actions, in an attempt to quell any expat disquiet about participating in tax fraud. Their first “line of defense” is usually to say “everyone does this and your American lawyers simply don’t know China.” When this doesn’t work, they often propose the expat employee become a director or an officer of the Chinese company’s Hong Kong entity and get paid the $70,000 for doing that. Yeah right. Anyone who knows China law enforcement, especially China tax law enforcement, knows this is never going to fly. See this Forbes article, China’s Tax Authorities Want You.

What we are also seeing, unfortunately, are a slew of expat employees accepting such split payment contracts to their massive detriment. We see this when the expat employee writes one of our China employment attorneys  for help against their China employer who just fired them or who is not actually sending any of the promised money via Hong Kong. These expat employees want to sue their China employer as though they have an employment contract for $100,000, when of course they don’t have such a contract because the Chinese employer is smart enough not to have put anything in writing about the $70,000 that was to have been sent from Hong Kong. Seriously, who is dumb enough to put their own tax fraud in writing?

This sort of non-payment has become so common I am now of the view that many (most?) China company employers that split salary payments do so not so much to engage in fraud as against the Chinese tax authorities, but rather to engage in fraud as against their expat employee. More than half the time when we get an email from an employee seeking our help in getting their $70,000 split fee payment, the employee has been working for her or his China employer for more than a year and that means their China employer saved about $100,000 over the last year (the $70,000 salary plus the approximately $28,000 in employer taxes and benefits it never had to pay) without violating a single law.

It’s like the perfect crime but it is not a crime at all. The employer simply managed to convince the expat to work at super low wages and there is no contractual record indicating otherwise. Sometimes there may be an email record, but the smart employer has made clear in its employment contract that the employment contract supersedes any prior written or oral promises or agreements. But even without that, Chinese law so favors the written and signed and chopped contract that not having such a provision likely won’t make any difference anyway. Many employers tell their employees they will make the $70,000 payment in one lump sum 6 or 12 months after the expat employee begins work, but then they never actually make the payment. Even without this promise, the expat employee does not want to quit because he or she believes doing so will mean they will never get the $70,000 — not realizing that continuing to work only puts them even deeper in the hole.

Then there are the instances where the employer does pay the employee out of country but stops for a while and then stops paying the out of China portion or fires the employee. The employee contacts our China employment lawyers believing he or she can sue his or her employer for damages based on a $100,000 salary. But how can they do this when their employment contract says their salary is $30,000? Are they going to stand up in a Chinese court and say, “excuse me, your honor, I know the contract says only $30,000 and I know my taxes show I have been paying income taxes on only $30,000” but this employer and I were together engaging in tax fraud against the Chinese government and so I just really feel like I am entitled to have this court enforce the oral agreement my employer and I used to defraud the Chinese government. Yeah, right.

All this very much reminds me of how in the old days when foreigners were not allowed to own real property in China they would buy real property in the name of their Chinese citizen girlfriends (it was pretty much always guys) to get around this prohibition. Then, once the girlfriend had the property, she would break up with her foreign boyfriend and keep the property, insisting that it was a gift. The foreigners would then contact my law firm wanting to sue their exes and we would have to tell them how we viewed that as folly because they would need to argue to the Chinese court that they had bought the real estate not as a gift to their girlfriends, but to have their girlfriends illegally hold the property in a sort of trust for them. Yeah, right.

Our Chinese employment lawyers frequently help expats with their China employment contracts. See China Expat Employment Contracts. Even when we are not retained, we like to stay in touch with those who wrote us for employment contract help just so we can know what happens to expats who negotiate their own employment contracts. The below is an email we have used for those who admit to having entered into a split payment employment arrangement:

What your employer has done is completely illegal and it puts you at risk. Both you and them are engaging in tax fraud but all that should matter for you is that you are engaging in tax fraud — assuming your employer actually pays you outside China, which they often do not. Your employer may claim otherwise but there is no doubt about this. You are supposed to be paying China income taxes on all of your earnings attributable to your work as a China expat employee. Plain and simple. But under this arrangement (again, assuming you do actually get paid outside China what you have been promised) you will not be doing that. If I were you I would go to my employer and insist it change this payment plan and if it does not, I would consider getting a new job, and fast. Just this week I wrote here how China is — in response to the US-China trade war- – stepping up its hunt for Americans violating China’s law just as you are doing. Do you really believe China would not love to call out and penalize Americans right now for tax evasion?

I am sorry I have to be such a downer, but if you were to end up in jail or deported I would not want it weighing on me that I did not at least warn you about your risks.
Expat readers, please consider this post your warning.

Counterfeit products on Chinese websitesOur China IP team regularly oversees requests to Chinese websites to take down counterfeit products. The success rate on getting these products removed within a week or so is North of 99%.

The following email (modified very slightly) crossed my computer the other day. It is from one of our China IP lawyers who does these takedown requests to another of our lawyers who needed information regarding the process. I am publishing it here to show that if the IP facts (and that typically means China IP registrations or in some cases, registrations in your home country) are in your favor, getting counterfeit products removed from Chinese websites is possible and usually terribly difficult. But you do need to be persistent and it certainly helps to be able to read and write and speak Chinese. Here is that email:

I have worked on numerous takedown matters across multiple websites, many on behalf of __________, _________, and _________. Every Chinese website has its own protocols, and you need to follow that site’s protocols before you should even think about going to court (and I’m sure the client could care less about court, as they just want the products taken down ASAP). You are also correct that only the copyright or trademark or patent owner or its authorized representative can make takedown requests. However, sites vary as to the sort of authentication they need for a Power of Attorney. We rarely deal with any that require a POA [Power of Attorney] to be authenticated or notarized — this is a big time sinkhole when you have to deal with government agencies, but not so much with private companies.

The most important thing is that if you want to get traction, you will need to show proof that the IP (copyright or trademark or patent) has been registered, and for some sites you will need to prove it has been registered in China. China is obligated to recognize copyrights registered in any Berne Convention signatory nation, but try explaining Berne Convention obligations to a 21-year-old customer service representative at a Chinese online marketplace and see how far you get. This issue is where a lot of complainants get bogged down, because in some situations, by the time they get their China copyright registration and can submit a takedown request, the damage has been done. How many people will still be downloading today’s big game six months from now?

Another thing to consider is that the more sophisticated/well-heeled the website, the more likely they have a formal takedown procedure, or perhaps even a full-fledged website for submitting complaints. This is what Alibaba does. For the smaller websites, you generally have to contact someone directly and hope for the best, because the instructions on the website are hopeless. But unless the website is an out-and-out pirate site, the IP complaint people at these websites are usually helpful, albeit within their highly limited constraints. They don’t want to host counterfeit or pirated content, and so long as you do all the work for them, they’ll be happy to take it down.

Finally, you should be aware that once this process begins, it’s pretty much ongoing. The pirates and counterfeiters don’t just give up because their first counterfeit product upload got taken down. We constantly need to monitor and report.

See also Removing Counterfeits from Alibaba, JD.Com, DHGate, Taobao, etc.

International M&ALately we have seen an uptick in international M&A work – some of it from China, some of it to China, some with other China alternative countries, like India and Malaysia, and some of it within the U.S. relating to U.S. subsidiaries owned by foreign companies. This increase coincides both with the world partially thawing from the Covid freeze and partially because we see increases every fall as companies look to make strategic acquisitions effective 12/31 or 1/1.

I frequently tell clients who are new to international transactions that these deals are like domestic transactions but usually require double the work, even on a good day. A lot of savvy domestic lawyers don’t really appreciate the dynamics of an international transaction (see Good Lawyers and Businesspeople Think They Know How to Draft China Business Contracts. They Don’t). Because each cross-border deal is different, the relative significance of the issues discussed below will depend upon the specific facts, circumstances, and dynamics of each particular situation. There are no “off the shelf” forms for these types of transactions. As a rule of thumb, you just need to be prepared for a lot of moving parts and a much slower timeline than you would like.

Political and regulatory risks abound in international transactions, even if both sides want the deal done yesterday. If the recent news coming out of China (a la Ant Financial and tech antitrust rules) and the U.S. presidential election haven’t driven this point home to you, I’m not sure anything will. Even though foreign direct investment (FDI) into the U.S. remains generally well received and rarely becomes a political issue for most source countries, with regard to anything China, all bets are off.

Prospective non-U.S. acquirers of U.S. businesses or assets should be familiar with the general country, state, and local landscape particular to their industry. And they or their legal team should undertake a comprehensive analysis of the U.S. political and regulatory implications in advance of any acquisition proposal or even initial discussion, especially if the target company operates in a sensitive industry or if the acquirer is sponsored or financed by a foreign government or organized in a jurisdiction where a high level of government involvement in business is generally understood to exist. That means China, and it means an increasing number of foreign countries, as well, especially with the current global economic situation.

When considering the concerns of federal, state, and local government agencies, don’t forget to include the employees, customers, suppliers, communities, and other interested parties. If you are a U.S. company, do they like you now? Will they like you after you have taken on a foreign partner or sold your company wholesale to a foreign company without your easing the transition process? This may not matter as much if you plan on leaving town, but if you stay put in your town after the closing, there may be unintended consequences for you and those you care about.

Do you make an announcement or not? If so, when do you make the announcement? Make sure you address this early in the discussions with your transaction partner. This topic is often covered in your M&A agreement, but you do not want your partner to make an announcement without your involvement, which could happen long before your purchase agreement is inked and signed. Your comprehensive communications plan should address all the potential constituents with a message tailored to their point of view. This is often something the buyer cares more about than the seller, but that is not always the case.

Your potential regulatory hurdles require sophisticated advance planning. In addition to securities and antitrust regulations, your acquisition may be subject to CFIUS review (see CFIUS in the News Again for Overturning China Deals Involving Sensitive Data), and acquisitions in regulated industries (e.g., energy, public utilities, gaming (gambling), insurance, telecom and media, financial institutions, transportation, and defense) may be subject to one or several additional layers of regulatory approvals. At the very least, you should discuss with your attorney whether CFIUS may apply and whether and when you may be required to disclose the planned deal, as well as the risks for not doing so.

Abiding by regulations in these areas is often complex, and political opponents, reluctant targets, and competitors may capitalize on any perceived weaknesses in an acquirer’s ability to clear regulatory obstacles, even if the executive teams and owners on both sides are fully engaged.

With the presumptive election of President Biden, we expect to see a general lessening of President Trump’s often showy interference in prospective international deals, but you should expect continuity in many of the enforcement policies at the federal level and in corresponding state regulatory bodies (this will be very state-specific). In addition, depending on the industry involved and the geographical distribution of the workforce, labor unions will continue to play an active role during the review process (this will also be very state-specific), which is also a significant political and regulatory risk.

As the globe descends again into another Covid-induced spiral, opportunities will continue to arise in the global M&A game. Sophisticated market participants will continue to hunt for arbitrage opportunities in their strategic acquisitions around the world. Everyone needs to continually refine their strategies and tactics as the global and local environment develop. Keep these political and regulatory risk mitigation concepts at the forefront and discuss them often internally and with your counterparts in your deals.

cybersecurity

Listen HERE or stream on SpotifyApple PodcastsGoogle Play, Amazon Music, Stitcher, or Soundcloud!

The large-scale shift to telework brought on by the COVID-19 pandemic is prompting businesses around the world to explore new avenues to engage with clients and friends. Harris Bricken is no exception, and we are happy to provide this podcast series: Global Law and Business, hosted by international attorneys Fred Rocafort and Jonathan Bench.

In Episode #31, we are joined by Doug Brush, a cybersecurity expert at Splunk. We discuss:

We’ll see you next week when we sit down with Joel Gallo, CEO of Columbia China League Business Advisory Co., a cross-border transactions and management consulting firm.

If you have comments on this episode or if you’d like to suggest topics for future episodes, please email globallawbiz [at] harrisbricken [dot] com.

And please follow Fred and Jonathan on social media to stay informed on upcoming guests and topics:

China expat employment contracts

As part of our China employment work, our China employment lawyers are often tasked with helping expats navigate the China employee onboarding process, including reviewing and revising their employment-related documents, such as employment contracts. This involves our making sure our clients’ contracts protect their interests and achieve their goals and minimize the likelihood of confusion and future disputes, which in turn saves them money.

As most of the major cities in China are getting back to normal and looking again at hiring foreign employees, we are seeing an uptick in needs in this area. Prospective/existing expat clients often ask us what are some of the main red flags we see in expat employment contracts. The below lists the expat employment problems we often see.

1. The employment contract contains illegal provisions that violate employee rights.

An employment contract with illegal provisions may in fact be completely unenforceable and a waste of your time and energy. Working in a foreign country is already challenging. Why not work for a company that strives to comply with the law and treat its employees with respect?

 

2. The employment contract’s Chinese and English versions differ.

This is actually quite common and most of the time, the Chinese company has done this deliberately to take advantage of the expat’s lack of Chinese language skills. Normally the Chinese version is the controlling version, therefore it is crucial you have a Chinese-speaking employment lawyer review that version. On the other hand, unless you are fluent in Chinese, having the English version is critical for you to be able to understand the terms of the contract before you join the company and while employed there. This is why we always emphasize the importance of ensuring the Chinese and English versions match each other.

If your prospective employer refuses to give you either version, that is another red flag. For example, some Chinese employers may tell you that you do not need an English version because the Chinese version is all that matters. Or some may tell you the Chinese contract is just a formality to get you a work permit. They are wrong. Your employment contract is really important as it memorializes all essential aspects of your employment relationship with the company.

 

3. The employment contract and the offer letter differ.

The Chinese company changes or even deletes key terms that were agreed upon by both sides. If the Chinese company does not agree to revert to the original language in the offer letter, it should, at minimum, explain why they made the changes that they did. A company that acts in bad faith during employee onboarding is a company that will almost certainly act badly when there is a problem/dispute in the future.

 

4. The employment contract is just flat out bad.

Many Chinese companies have no clue about what it takes to comply with China expat hiring rules or with what makes sense for a foreign employee compensation package and their employment contracts reflect this. We have seen just about every variety of bad Chinese employment contract possible, and the below are just a small sampling of the sort of “mistakes” we see:

  • The employment contract refers to other documents, such as a non-compete agreement, that have not been provided to the expat employee. If there are no such documents, any reference to them should be deleted to eliminate confusion. If there are such documents, they should be reviewed and negotiated.
  • The employment contract is missing legally mandated provisions.
  • The employment contract does not provide the sorts of perks typically provided to expats.
  • The contract fails to clearly define critical terms.

You want to root out these sorts of employment contract problems because if not fixed, it is nearly always the expat employee who will pay.

 

 

international manufacturing lawyers

Manufacturing agreements between product buyers and their manufacturers typically come with all sorts of clauses dealing with choice of law, indemnification, time of delivery, failure rate, price, payment, and various other contractual provisions. The Bill of Materials can often make or break the success of a manufacturing relationship, but this document is too often either ignored or given short shrift.

The Bill of Materials is a list of the components to be used in fabricating the proposed product. A good Bill of Materials, inserted as an appendix or addendum to an Original Equipment Manufacturing (OEM) agreement, should specify in excruciating detail exactly what your manufacturer must use in manufacturing your product. A well drafted and precise Bill of Materials minimizes the likelihood of confusion and future mistakes, which in turn saves you money by reducing product defects and recalls.

My law firm’s international manufacturing lawyers have seen far too many OEM manufacturing agreements that did not have a Bill of Materials and far too many OEM agreements where the Bill of Materials was not made a part of the contract.  Perhaps even worse, I have seen Bills of Materials that were made a part of the contract, but that allowed the manufacturer to substitute any component in the Bill of Materials whenever it felt like it. There is oftentimes nothing wrong with allowing your manufacturer to make substitute materials with your knowledge and approval, but there is a lot wrong with a Bill of Materials that gives your manufacturer complete discretion to substitute in materials.

When a problem arises, you should be able to cross-reference your Bill of Materials with the actual product to see if the correct components are present. When I see manufactured products with high return or defect rates, the cause is almost invariably the manufacturer having used cheaper components. But far too often, I also find that there was nothing in the OEM contract or in the Bill of Materials (or in the two of them working together) that contractually prevented the manufacturer from having done exactly what it did. Many times the quality of the Bill of Material will determine whether or not you have any recourse against your manufacturer for bad product.

If you want to reduce your chances of defective or dangerous product, you cannot just rely on your manufacturer to do the right thing in terms of your product’s materials or components. It is your responsibility to make sure your manufacturer uses the correct materials in manufacturing your product. A well drafted Bill of Materials is the first step towards that.

For more on international OEM agreements, check out International Manufacturing Contracts: The Basics.

Best practices for doing business in China. The two minute version.

I often “clean” my computer on Saturday and in doing so today I found my notes from a talk I gave a long time ago in New York, focusing on what it takes to conduct business successfully in or with emerging market countries. If I recall correctly, I was on a panel with a couple of other international lawyers and we were each to lead it off with two minutes to talk about the ONE thing companies doing business internationally should know. The below is what I wrote in preparation.

Make the law your friend. If you operate both legally and with an eye towards the legal ramifications of what you do, you will have greater leverage with both the companies and the governments with which you do. You will also sleep better at night, both in the short term and the long term.

Use Good Contracts. As an example on the company side, if you get bad product and you have a great contract, you almost certainly have leverage to require your  supplier to remedy the problem. If you have no contract, you almost certainly lack the leverage to get your supplier to fix things.

Make Friends with the Government. On the government front, if you are operating legally and paying your taxes, you should consider introducing yourself to the appropriate government authorities so they know who you are before you have any problems so that if and when you have any problems, you have people who already know you who can assist.

What would you have said if given two minutes?

As reported in the South China Morning Post (SCMP), Stanley Black & Decker has closed its Shenzhen factory, “[laying] off all of its 1,000 workers after 25 years of operations.” This, according to the SCMP, “reflects the changing business environment in the world’s second-biggest economy.” In reality, however, it highlights long-standing, ongoing China risks.

Stanley Black & Decker’s departure is being spun as further evidencing “Shenzhen’s transition from a manufacturing base, which relies mainly on relatively cheap land and labour, to a technology hub – i.e. China’s answer to Silicon Valley.” Yet “the entrance [to the Shenzhen factory] was swarming with human resource managers and labour agents who were trying to persuade laid-off workers from the closed factory to join other ones.” One human resource manager quoted in the SCMP said, “Shenzhen factories are facing a sudden labour shortage … as many factories have orders pouring in and shifting from overseas.”

1. China Problems

Shenzhen is changing and moving up the value chain, but its old-school manufacturing sector is alive and kicking, as shown by the demand for the laid-off Stanley Black & Decker’s employees. Looking closely at the story, it appears Stanley Black & Decker’s decision was not the result of falling out of place in the brave new Shenzhen – but rather of the same old China problems, including the following:

A. Tariffs and AD/CVD Duties on China Products

According to a worker, “the Shenzhen factory focused on supplies to the US market, but in the past couple of years, we had been producing semi-finished products and shipping them to Vietnam’s plant for assembly.” There may be a variety of reasons for this shift, but it’s hard to imagine the tariffs imposed on a broad range of Chinese products by the United States didn’t play a role. Though a new Biden administration might provide some tariff relief, it’s worth remembering there are also numerous antidumping and countervailing (AD/CVD) orders against certain Chinese products, some far predating Trump’s trade war.

B. Land Use Rights are Never Certain

The same worker quoted above “speculated that the upcoming expiration of the company’s land lease could have been a factor in the closure. Land lease prices have been surging in Shenzhen due to limited supply. ‘Some of us guessed that the factory’s days were numbered, as the land lease would expire next February.'” China’s real estate market operates in a fundamentally different way than that in most market economies. As made clear by China’s Land Administration Law, “the land in urban areas is owned by the state” (Article 9) and the most a private company like Stanley Black & Decker can aspire to get in China are land-use rights (see Article 7 of the Urban Real Estate Administration Law), which are granted by the authorities. According to Chinese regulations, the maximum validity of a land-use right for commercial purposes is 40 years and when a company’s land-use rights are about to expire , they are at the mercy of the local authorities. If the authorities are keen on, say, redeveloping the factory land into apartments, there will be little the company can do to sway their decision. The real estate regime in China, especially regarding commercial activities, has uncertainty baked into it. In fact, trouble can arise even during the lease period. Land is subject to expropriation just about everywhere in the world, but the risks are obviously higher when the government that wants to take the land is already its legal owner.

C. Labor

According to the SCMP, “there appeared to be relatively less anger among workers and the local community over the closure, unlike a decade ago when the relocation of the Stanley Black & Decker factory from one place in Shenzhen to another triggered a massive protest.” The availability of jobs for at least some of the workers (even if “not offering pay and welfare benefits comparable” to Stanley Black & Decker’s) probably helped assuage worker anger over the closure. Notice, though, that even relocating the factory within Shenzhen led to a serious protest in the past. Without doubt, if an American company required its workers to considerably increase their commute time, it could lead to serious labor dissatisfaction. In the end, though, Americans generally have a clearer understanding of the demands of a market economy, if only because it’s the only kind of economy most Americans will have experienced. By contrast, for many Chinese, particularly those steeped in the tradition of the all-providing danwei, the idea that an employer can fire at will – or even move into new premises at will – is anathema to their view of how the world should work. Such thinking is especially prevalent among the Communist Party cadres who run local governments (whose lives retain many of the danwei arrangements, such as employer-provided housing). They may look with disfavor at layoffs and inconveniences to the labor force, and treat companies – particularly foreign companies – accordingly. Even officials who want to push their localities in the direction of market reform (and/or who have a stronger appreciation of the tax revenues from the private sector) will be wary of any moves that could lead to unrest. As with the land issue, the bottom line is companies operating in China are subject to government interference that would be unthinkable in the United States.

D. CCP Lies and Randomness

Stanley Black & Decker’s departure was “even more surprising after the state-run Guangdong Television [GDTV] ran a report on the factory in September, pointing to it as a success story amid celebrations for the 40th anniversary of Shenzhen being named a special economic zone. The report claimed the company was planning to continue investing in automation and digitization, with an aim of turning it into a ‘smart’ factory by 2028.” Well, one of two things happened here: Either GDTV reported falsehoods (very plausible) or, despite Stanley Black & Decker’s efforts to fit into the new “Silicon Valley with Chinese Characteristics,” the local authorities decided it needed to go. Maybe they decided the area needed more apartments and/or they could not agree on new land-use terms with Stanley Black & Decker, or maybe word came down from on high that the American company was to be shown out the door: Enjoy Vietnam and don’t let the door hit you as you cross the Red River.

A lot is surely changing in Shenzhen and China – but a lot isn’t. Just as beyond the glitzy skyscrapers of Shenzhen’s central business district there are large swathes of unlovely industrial areas, the fundamental China issues for foreign business remain beneath the hype.