International Business Law

I am constantly giving speeches on protecting intellectual property from China.  I used to start that talk with something like the following:

If you are doing business with or in China, you have to plan on someone in China making a play for your Intellectual Property.  It’s not a matter of if, but when. It may be your partner, your distributer, your manufacturer, your sales manager, your top scientist, your supplier, or your customer who seeks to take and then use your IP.

Big Chinese companies steal IP.  Small Chinese companies steal IP.  State owned Chinese companies steal IP.  Privately owned Chinese companies steal IP.  And despite the beliefs of many Americans just starting out in China, Chinese companies with people who speak great English and invite you to their family weddings also steal IP.

I have since added something along the lines of the following to it:

The reason Chinese companies are going to be so quick to steal your IP is because if you haven’t done what you should be doing to protect your own IP, they figure that they will get away with it.  They’ve done the cost-benefit analysis and the benefits of stealing your IP outweigh the costs.  It’s as simple as that.  US companies do the same analysis but because of the likelihood of getting caught and punished here their decisions tend to be different.  It isn’t so much that American companies have higher morals, it is just that our system is better for preventing IP theft.

And if it’s a really long talk, I might even add something about how the US was known as one of the worst IP scofflaws back in the late 1800s.

All of this is a preface to a delightful guest piece we received from David Woronov, a Boston based international business and IP lawyer with the Posternak Law Firm.  David’s piece is on a Chinese company scammed by a US company.  Trust me when I tell you that this sort of “reverse” scam is not uncommon and is bound to increase as more Chinese companies come to America believing American companies don’t cheat.  I saw a lot of this sort of thing with Korean companies fifteen years ago and with Russian companies ten years ago.  Eventually, foreign companies coming to the US come to realize that we too have our fair share of bad apples and that due diligence is important everywhere.  In other words, the “China scam” can easily go both ways.

Here’s David’s take:


Early Due Diligence and Security for Payment—They’re Just as Crucial for Chinese Trying to Do Business in the West

Okay, it’s in vogue in the Western media to warn readers to be suspect of Chinese pirates, hackers, thieves and other ne’er-do-wells, as if they (and their government) have a virtual monopoly on such practices.  This may be paranoid, ignorant, racist, and dangerous at any number of levels, including as some might be lulled into “letting down their guard” when dealing with dangerous situations in other countries, or even in their own backyards.

At China Law Blog, perhaps the message should be that Chinese businesses also need to conduct their own due diligence, and act with care, prior to and when dealing with business counterparts from or in the West.  Many in China still believe that if they are dealing with an American or European company, they do not need to worry about whether or how they will be paid, and they do not need to devote time or energy to obtaining security or collateral in advance.  That is not a safe manner for them to proceed in China, the US, or anywhere else!

In a recent case here in the United States, my firm represented a Chinese company as a plaintiff, that had acted as Chinese sales representative for a defendant high tech manufacturer based in the US, just prior to the 2006 Olympics in Beijing.  The US company was a small public company, whose stock had once been listed on the American Stock Exchange, and is now only traded “Over the Counter” (and as of this writing was trading for just under $1.00 per share).  As a publicly registered company, the plaintiff could have accessed the defendant’s financial filings with the Securities and Trade Commission before it agreed to the arrangement, and if it had, it would have learned that virtually all of the defendant company’s assets (including all of its intellectual property, equipment, etc.) had been pledged as collateral for small, short-term loans by a venture fund. Such a review would also have revealed that the lender had constantly had to extend the loans (each time, on a short-term basis) and would then increase the amounts of the loans each time they had come due, while also ratcheting up interest rates and adding tougher covenants and terms.  This most basic review would have revealed that the defendant company was being held in a tight and spiraling cash corset.

Ignorant of all this, our Chinese client agreed to facilitate selling a fair number of the defendant’s products for the 2006 Beijing Olympics.  In fact, our client was relying on a cash commission payable on each sale, but it had not thought it necessary to arrange for an enforceable “master contract” (in either Mandarin or in English) with the defendant US manufacturer — which at least would have opened up the possibility for a law suit against the US manufacturer under Chinese law … but no such luck.

Back when they started fulfilling the original sales orders they had received through our client in China, the US company unilaterally listed our client in its other contracts as an “authorized repair station” in China. The US Company also listed our client as an authorized repair station on its product materials distributed in Chinese, and even sent emails telling purchasers that our client could train their staff, calibrate their machines, and handle their repairs–none of which was true.  Early on, our client did attempt to go out of its way to help, to the point where it had rented (with its own money) some large tracts of land in Beijing, for a period of a few days, that could be used for training purposes. As part of our lawsuit, I visited our client’s offices in Beijing, and immediately saw that although it is definitely a very “real company” — it was a busy, carpeted office complete with cubicles, conference rooms and reception areas, in a tall tower in Chaoyang — it definitely was NOT a warehouse, nor a calibration laboratory, a training facility or an electronic repair shop.

So when our client finally become aware of what was going on, and flat-out refused to its being listed as a servicer (for which it was not qualified, had no resources, and most significantly, was not being paid or  trained), and also demanded to be paid what it was owed for commissions, there was the crucial breakdown between the two parties. The US company then promptly sent an email unilaterally “terminating” the arrangement with our client but conveniently neglected to send notices to the customers themselves, who continued to bombard our client with calls and demands.

Our client in China was owed a pretty hefty amount in commissions and other fees for what it had done, but not enough to justify the potential costs of a full blown US law suit.  We tried to negotiate with the US company, but when it became apparent that we would have to initiate a lawsuit to toll the statute of limitations and to get the defendant US company to focus on this.

After we filed the suit, the defendant hired litigation counsel, and out came the defendant company’s defenses.  They claimed that our client had intentionally tampered with their products (despite that all of the products had been shipped directly to the end users in China) and that somehow our client had tortiously interfered with and damaged the US company in China.  Ordinarily, this all might have been quickly (but never cheaply) dealt with in litigation, but under these circumstances it was all too much.  At the end of the day, there would have to be enormous direct expenses (as well as indirect opportunity costs) for our client’s staff and other witnesses to fly back and forth from China to the US to attend depositions and hearings, as well as the costs of having to hire numerous interpreters and translators.  Most importantly, we were concerned about the ultimate creditworthiness of the US company defendant. Our client might win all the battles, but it would still lose the war if it could not collect from a defendant that appeared to be teetering near insolvency.

We ultimately reached a cash settlement, leveraged on the liability disclosures that ultimately had to be reflected in the US company’s publicly disseminated financials (it had repeatedly delayed releasing its financials, well past the times required under applicable federal law, but as things dragged on, and investors began to clamor, finally it HAD to disclose this case in its footnotes), and the fact that the defendant had “suddenly” realized that it “might” need our client’s assistance cleaning up some export control issues.  So after a number of years, our client received a fraction of what it was owed, especially after all the costs were netted out.

As our client now knows (having learned it the hard way), just because one is working with a Western company, that alone does not mean that it should let down its guard and ignore proper due diligence processes and its common business sense and practices.  China may be perilous, but so is most of the business world.  And an ounce of prevention is much better than many pounds of cure — no matter what the currency.

What do you think?


Very helpful post over at the always helpful International Business Law Advisor Blog.  The post is appropriately entitled, The 5 Key Factors You Must Consider When Establishing a Foreign Corporation [link no longer exists] and it lists out the following:

Decide on Corporate Form:  The post talks of determining the right corporate form for the country in which you will be establishing your company. For China, this might mean Joint Venture, Representative Office, Wholly Foreign Owned Entity (WFOE), etc.  For more on forming a company in China, check out the following:

Identify Your Business Purpose:  The post notes how “unlike in the U.S., the business purpose of an entity in a great number of foreign jurisdictions require that the business purpose of the entity to be described in detail.”  This too is true of China, where what you list as the scope of the business can end up limiting what it can do. For more on this, check out the following:

Choose the Corporate Name:  The post notes how a “great majority of foreign countries have specific requirements regarding corporate names” and this is true of China as well.

Determine the Officer and Director, if any:  The post notes how some countries do not recognize the U.S. concept of “director and officer”  and of how residency requirements may also apply. China definitely has a different leadership structure than is familiar to Americans and this oftentimes results in problems.

Quantify Capital Requirements: The post notes how minimum capital requirements “necessary to form an entity varies by country.”  This is actually true within China where some cities have fairly low minimum capital requirements and others have much higher such requirements.  For more on China’s minimum capital requirements, check out the following:

Okay, so what is the missing, most important consideration of all?  Whether it even makes sense to form a company overseas.  This is by far the most important and also most complicated in forming an overseas entity.

Is forming a company overseas really the best way to accomplish what you are seeking to accomplish?  Might you be able to sell your product or services pretty much as well via a licensing, franchising, or distributorship relationship?  Do you really need a company in a foreign country to have your products made there or your research conducted there, or might you be better off just outsourcing?

Most importantly, is going overseas really right for your company.  Running a single domestic company is tough enough.  Now consider running two or more companies at the same time, with one or more of them being in a foreign country.  Or as my friend Ben Shobert would say, Are You China Ready?