We recently did a set of tooling agreements for a client doing business in China and as a part of that, one of our China lawyers sent the client the following instructions on making sure those agreements were properly signed:

As noted above, you must ensure that the tooling agreements are properly executed by the Chinese companies that will control the tooling. This means that you need to make sure that each of these agreements is signed by a duly formed Chinese company and by the legal representative of these Chinese companies, and that the names and addresses of the Chinese companies are in accord with the information registered for those companies and that the formal company chops are used to seal the agreements. […]

In terms of verification of the Chinese company information, at minimum you need to do the following: 1) personally visit each factory; 2) obtain the business card of each person who will sign on behalf of each Chinese company and have that person give you a specimen of their company’s chop; 3) obtain a copy of a previously executed company document to verify the authenticity of the chop; 4) obtain a copy of the business license which will provide the registered address and the name of the legal representative. If ANYTHING about the tooling agreement is inconsistent with the information you receive, DO NOT EXECUTE it and do not do business with the manufacturer. Even a simple mistake in the address can lead to invalidity of the contract

A few months later, another of our China lawyers did some China NNN Agreements (a/k/a NDAs or Non Disclosure Agreements) for the same client.  NNN Agreements are not long or complicated agreements and they are typically discussed and even entered before the parties have a much of a business relationship. Our client asked our (and its) lawyer whether it would need to go through the same long and somewhat difficult process for the signing of each NNN Agreement, just as it had done for its tooling agreements.

Our lawyer responded as follows:

The short answer is that the same standard of enforceability applies to all China business contracts.
I understand your concern that the legal representative of the Chinese party may not always be willing to sign your agreement. It is always preferable (and safer) to have the legal representative sign, but if the agreement is sealed with the company chop then it should still be enforceable even if it is signed by some other company representative.
With regard to the verification steps listed, none of them are, strictly speaking, mandatory. That is, they do not themselves make a contract any more enforceable. But they are all highly advisable. The more steps you take, the more confident you can be that the contract has been properly executed by the proper company. Of these steps, securing the business license of the Chinese company is probably the most important, for two reasons: (1) it provides an easy method of verifying the name and registered address of the company and the identity of the legal representative, and (2) it is extremely easy for the Chinese party to provide, and if they can’t do so it is usually a warning sign.
It is that “easy.”

David Dayton over at the Silk Road International Blog did an excellent post on China manufacturing a couple years ago, but I just saw it today. The post is entitled, “What to ask for at a trade-show (and afterwards too),” and it starts off with Dayton saying that he is writing the post because he is always getting asked what to look at for at trade-shows.  The post is full of excellent advice, some of which I highlight below.

Dayton starts by listing “First questions” to ask of manufacturers you meet at a trade-show and are considering using.  A select portion of those questions are below, along with my comments in italics:

  • Where is the facility and can you go to visit (this week while you’re in the country)?  Visiting the facility may be the single best thing you can do to determine whether you are going to be dealing with a high quality Chinese manufacturer and, on top of that, I am convinced that just visiting increases your chances of being taken seriously by your manufacturer, which in turn, increases your chances of getting good product.  
  • Do they have business documents that they’ll let you see?  I am not sure exactly to what business documents Dayton is referring, but generally it is a good idea to, at minimum, make sure that the company you are dealing with is actually registered in China and is truly the same company that makes your product.  It also never hurts to see documents showing that your potential manufacturer has done this before. American companies tend to be reluctant to ask for this sort of thing, but you should know that Chinese companies are not.  Just asking for these documents will separate you out from many others and thereby earn you increased respect, which definitely can impact product quality. 
  • Will they let you talk with engineers and other managers?  If they will not allow this, you should be suspicious. 
  • Will they allow 3PQ?  If they will not, you should be suspicious.
  • Can they give you referrals?  Note that Chinese manufacturers sometimes refuse this request for valid reasons.
  • Can you meet and even QC sub-suppliers?  If your Chinese manufacturer is going to keep the identities of its sub-suppliers a secret, your odds of quality control problems just went up. 
  • How do they deal with non-conforming product?  Not sure if I agree with this one as we are of the view that our clients should be telling the Chinese manufacturer how to deal with non-conforming product.  Generally, we seek a refund of any amounts paid, along with the destruction of all of the non-conforming product.  

Dayton goes on to point out that even once you have found a “great factory,” you still have to determine whether it is a good fit for you.  He proposes asking the following excellent questions to find out:

  1. What is their average order qty?  Is your order similar?
  2. What is their average order time?  Is your lead time sufficient?
  3. Have they done similar projects (similar levels of customization, similar components)?
  4. Can you communicate with them effectively and do you feel comfortable working with them?

Lastly, Dayton lists out what Western companies need to do on “their end of the deal”:

  1. Always keep you word concerning dates and monies and anything else that is your responsibility.  Check.  
  2. Always take into account the reality that if you’re late with art (or money or answers) it will cause production delays (usually longer than your delay).  Check
  3. There will be problems, so take notes and keep records and follow up on anything that you’re not clear on.  Check.
  4. NEVER MAKE ANY ASSUMPTIONS.  Double-check.  For more on this, check out China Legal Issues For Business. The Ten Minute Version.
  5. Never make any changes to your specs or to your contract.  I disagree with this one, so long as the changes are handled appropriately.  
  6. File all legal work in your home country and in China BEFORE you start passing out specs to anyone (even at the show).  I think what David is saying here is that you need to make sure that all your intellectual property protections are in place BEFORE you start flashing around your IP.  For more on this, check out Register Your China Trademark Now. Then Register It Again With Customs.
  7. Spec out all your details and present them in a consistent and clear format.  Check.
  8. Meet FACE TO FACE with your factory as much as possible.  Check.
  9. Admit when problems are your fault and take responsibility for them.  Check.
  10. There will always be problems—usually you can work through them.   But always find a back up facility just in case.  Check
David’s post has many more tips for those looking to manufacture product in China and for those already manufacturing product in China and if you fit either of those two categories, I strongly urge you to check it out.
What do you think?

Lawyers love checklist and China lawyers are, of course, no exception.

Me, I love clients, not only because they are the lifeblood of my law firm and thus my livelihood, but also because they so often are the ones who stimulate the ideas for this blog. I just spoke with a client who asked me to outline the legal issues he needs to consider as his company looks at doing business in China.

Amazingly enough, this is the first time I have been asked so explicitly for such a checklist.

This post “issue spots” the most common legal issues companies face when going to China. Though far from exhaustive (and not intended to be so), this list highlights the key legal issues foreign companies must consider when doing business in China.

  • Are You Legal? China has all sorts of requirements for doing business in China. If you are going to be doing business there anything more than occasionally, you probably will need to form a legal entity to do so. This entity can be a WFOE, a JV, or a Representative Office. Some businesses that are perfectly legal in the United States or in Europe are illegal in China.
  • Contract.  In almost every instance, it is wise to have a written contract and it is almost always best to have this contract be in Chinese. Chinese contract law is far less willing to imply things than western law.
  • Intellectual Property/Trade Secret Protection. Your intellectual property (IP) rights in your own country do not generally extend to China. To secure protection of your trademarks and patents (and to a lesser extent copyrights) in China you must register your rights there. Do it or do not complain when they are “stolen.” You should also be using your contracts (and not just your NDAs) to protect your IP in China.
  • U.S. Foreign Corrupt Practices Act. The United States vigorously enforces the FCPA, which penalizes improper payments to foreign officials by U.S. companies. In certain situations, U.S. companies can be liable under the FCPA for payments made by their Chinese partners. The most common situation is when the U.S. company uses the Chinese company as a distributor of the U.S. company’s products. Know these laws and know how to avoid running afoul of them. And make sure that your employees are trained in these laws. Canada and Europe have similar corrupt practices acts.
  • Compliance with Export Control Laws. Late last year a company asked one of our China attorneys to draft sales contracts for their technology product. Our first question to them was whether the U.S. would even allow them to export their product to China. This question had never even occurred to them, but it turned out that exporting their product to China would be illegal under U.S. law. Years ago, I was approached by a client ready to ship product to North Korea that would have violated U.S. prohibitions on doing business with that country. The client was simply unaware of the law. Some products (certain types of software are a good example of this) can be sent to China only with a validated license.
  • Product Liability Laws. Not sure this would have made it to this list a month ago, but in light of the recent issues surrounding toxic pet food, it deserves to now.
  • Antitrust/Labor/Tax/Termination Issues. If you are going to be doing business with China or, even more so, within China, these issues are often relevant, particularly since Chinese laws on these can be so different from those to which you are accustomed.

I think this covers the basics.

China’s recently stepped up effort to root out foreign companies doing business in China without being registered to do so has caused a rash of China consultants to retain the China lawyers in my firm.

From our work in forming China WFOEs for these consultants, we have learned that many China consultants are falling dangerously short in various other legal aspects of their business as well. Indeed, if we were to single out the foreign businesses in China most often guilty of underestimating their legal risks, it would be China consultants. China consultants seem to have been in China so long that they have lost sight of the fact that when push comes to shove (or as we lawyers like to say, when a deep and easy pocket needs to be found) they are the American/European/Australian company that is going to need to answer for what happened. These China hands also fail to recognize how much China has changed in the last decade and that doing business in China today is just not the same as it was five years ago. Not even close. If you are a Western consultant hired by a Western company to assist in China, you must realize that if something goes wrong for your client you will be your client’s first choice for legal redress.

What can go wrong? And what can you as a China Consultant do to prevent or ameliorate it? Overall corporate planning to protect your personal assets is an absolutely necessary first step. Beyond that however, and more specifically to China, you can do a lot to protect your client and thereby protect yourself.

We have seen the biggest problems with sourcing consultants that assist in finding Chinese manufacturers. A typical sourcing project, might go like this:

  1. Western company retains a product sourcing consultant to find the best Chinese widget manufacturer in terms of cost/quality/dependability.
  2. Consultant requests and secures sample widget from manufacturer.
  3. Consultant meets with countless Chinese manufacturers in search of the best one.
  4. Consultant recommends company Z in China to manufacture 100 million widgets.
  5. Consultant is to be paid a percentage of the manufacturing costs.
  6. Company Z starts manufacturing the widgets.

By this point, I am guessing the sourcing consultants reading this are saying, “yes,” while the China attorneys out there are already apoplectic. Let’s deconstruct this hypothetical project and note where the consultant has potentially harmed the client and needlessly taken on huge liabilities for itself.

  • The sourcing consultant agreed to find “the best” widget manufacturer. Is that best in China or best in the world? What if the widget manufacturer charges one hundred dollars a widget for the 100 million widgets, but your client’s competitor finds another widget manufacturer who will do it for ninety dollars. Are you liable for the difference? Even worse, what if your client’s competitor gets the same Chinese widget manufacturer to do 100 million widgets for ten dollars less? Do you really think a US jury is going to believe you were doing your best when your fee was a percentage of the final costs? Are you responsible for the Chinese manufacturer’s late deliveries? For the Chinese manufacturer’s bad product?  Is it clear exactly what your percentage is going to be based and have you set things up so that your client cannot just go around you? The Solution: Use a well-crafted written contract to make clear exactly what you will and will not do. Put in a non-circumvention provision to make sure you get paid.
  • If you take a sample to China and start showing it to potential manufacturers without FIRST putting in place various safeguards, you are courting disaster. The sample could be used for counterfeiting. We had a consultant call one of our China lawyers in a panic after returning from China to learn that one of the manufacturers to which he had shown a sample had already started manufacturing the product for someone else using the consultant client’s trademark which it had gleaned from the Internet. The Solution: Never show a sample or product plan or reveal your trade name(s) without first making the Chinese manufacturer sign a China-centric NNN Agreement (essentially a hopped up NDA that protects against competition, circumvention and disclosure). Chinese manufacturers tend to be quite familiar with NNN agreements and if you give them a simple and reasonable one, in Chinese, they will sign it.
  • You the consultant must do more than simply negotiate the price and delivery dates or you should at least make clear in writing that these are your only tasks. Typically, product sourcing consultants oversee the OEM contract with the manufacturer and by doing so, they face major liability issues if that contract is not up to snuff. You are the “China guy” and your client is counting on you to guide it through China’s business minefields. You are the one who is supposed to know anything and everything about what it takes to do business in China. Equally importantly, with the manufacturing of its product, your client is probably turning over to the manufacturer all sorts of critical intellectual property. Your client probably thinks that its existing patents, trademarks and copyrights will protect it in China, but a court will expect you as the China expert to know better. The Solution: Put in writing with your client that you will not be providing it with legal advice and that it will need to retain its own lawyer to draft the OEM agreement with the Chinese manufacturer. Put in writing that it is your client’s responsibility to protect its intellectual property in China and that to do so, it must register its IP in China, either through a lawyer with whom you connect them or independently).

Just remember that your client sees you as the expert at doing business in China and it is looking to you for help in all areas and if you fall short in any way, you are at risk for a lawsuit.

China consultant, protect thyself.