China Manufacturing Has Changed
Outsourced manufacturing has changed dramatically in recent years. Making products in China is much more complex now than it was five years ago, due to these factors:
- The U.S. tariffs have profoundly impacted companies that ship products from China to the U.S. or make products in China. Many of my law firm’s clients won’t place an order without first consulting with one of our international customs lawyers.
- Chinese manufacturers fear losing their foreign buyers to other countries that can avoid the tariffs. This has led them to steal the IP of their current or potential product buyers and compete with them directly.
- Chinese economy is doing poorly, and countless Chinese manufacturers have shut down in the last few months and many more are teetering on the verge of insolvency. My firm’s international lawyers have been seeing a massive increase in Chinese manufacturers taking money from foreign companies and then vanishing without ever making a single widget. I personally have heard from around a half dozen US and EU companies that have gone out of business after losing huge money to a disappeared Chinese factory.
- Yesterday, in Fighting Back Against Fake (and Real) Sinosure Claims: A Primer, I wrote about how desperate Chinese factories are calling in Sinosure in an effort to avoid having to shut down, and how Sinosure is wreaking havoc with US and EU product buyers.
Big Company and Small Company China Manufacturing Risks
Changes in outsourced manufacturing are not hitting our clients equally. Our biggest clients have been relatively unaffected, whereas far too many of our small company clients have gone under.
Before doing anything with anyone in China, the typical big company secures its China trademarks for its company name, its brand name, and its logos — at least whatever names and logos it will be putting on the products and packaging it will be having made in China. For why this is smart, check out China Trademarks: Register Yours BEFORE You Do ANYTHING Else. This big company also likely required each of its potential Chinese suppliers sign a China NNN Agreement before it revealed any trade secrets.
Then once the big company determines the Chinese factory (or factories) it will use to make its products, it makes that factory sign a comprehensive manufacturing agreement that contains well-thought out contract damages/liquidated damages provisions and IP protections. In other words, the typical big company analyzes its various China risks, and it registers its IP in China and drafts its contracts for China to reduce those risks.
Unfortunately, small companies often do not act similarly even though their risks are now sky-high because so many Chinese companies are at great risk of going under and their fear of going under is causing them to do things they were less likely to do when times were good.
China’s New and Increased Manufacturing Risks
In China Trademark Theft. It’s Baaaaaack in a Big Way, we discussed the massive increase our China lawyers are seeing in quick-fire trademark thefts:
Sstarting about a year or so ago, our China trademark lawyers started getting a ton of China trademark theft calls and the number of those calls has been accelerating ever since. Why has the tide on trademark “theft” come in again? Two reasons. One, there is hardly a sole in China who does not know how to get around the prohibition on an agent registering the trademark that rightfully should go to the foreign company for whom it is acting as an agent. If your manufacturer in Shenzhen wants to secure “your” trademark in China it will not register it under its own name as it knows that cannot work. So instead of registering the trademark under its own Shenzhen company name, it will ask a cousin or a nephew in Xi’an to register it under its company name, making it nearly impossible for you to invalidate the trademark. Two, many Chinese factories are hurting right now, and they desperately want to improve their profit margins. What better way to do so than to sell a product under a prestigious or well-known American or European brand name — or even just any brand name? See Your China Factory as your Toughest Competitor.
We are also seeing a massive increase in situations where a foreign company has paid its Chinese factory for its products, yet never received anything, or received product of such bad quality as to indicate the Chinese factory did not even try. We are also seeing an increase in small companies getting victimized by the China bank switch scam. See China’s Most Common Scams. But with this new twist: we believe Chinese factories are more often participating in this scam because they think they will soon be out of business and so they are grabbing money however they can. Yesterday, I wrote about how Chinese factories are working with Sinosure to compel foreign companies to pay them money the foreign companies do not owe. See Fighting Back Against Fake (and Real) Sinosure Claims: A Primer.
Why do all of these terrible things happen to small businesses that want nothing more than to have good product made in China? To at least some extent it is because they have let their guard down at the absolute worst time. Far too many are either unaware of how bad and how risky dealing with Chinese factories can be, or are simply choosing to ignore this.
How to Reduce Your China Manufacturing Risks
What should small companies be doing that they can actually afford to do? What is the baseline of what these SMEs should be doing to protect themselves from China? SMEs should, at minimum, be doing the following:
1. Check out their existing and potential China factories. See On the IMMEDIATE Importance of China Manufacturer Due Diligence.
2. Register their company name and brand name as China trademarks before revealing either to anyone in China.
3. Make their potential China factories sign a well-crafted China-centric NNN Agreement before revealing ANY secret.
4. If it makes economic sense to do so, have a well-crafted China-centric agreement that protects important molds and tooling and that specifies exactly what it is the Chinese factory will be making and exactly when it must deliver that. See Getting Good Product From China; Specificity is THE Key To Your OEM Agreement.
5. Check in from time to time with their China factory, if only just by phone. Talk with the factory owner. Ask “how things are going.” Oftentimes they reveal their fears.
6. Read China’s Economic Slowdown and YOUR Business: The Times they are a Changin’.
7. Do not go to China without first discussing your risks of doing so with someone truly familiar with those risks. I have been doing a ton of China travel risk assessments lately and around ten percent of the time my advice is not to go to China under any circumstances. Note that the US State Department recently raised the risk level on going to China, with the following explanation:
Exercise increased caution in China due to arbitrary enforcement of local laws as well as special restrictions on dual U.S.-Chinese nationals.
Chinese authorities have asserted broad authority to prohibit U.S. citizens from leaving China by using ‘exit bans,’ sometimes keeping U.S. citizens in China for years. China uses exit bans coercively:
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- to compel U.S. citizens to participate in Chinese government investigations,
- to lure individuals back to China from abroad, and
- to aid Chinese authorities in resolving civil disputes in favor of Chinese parties.
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In most cases, U.S. citizens only become aware of the exit ban when they attempt to depart China, and there is no method to find out how long the ban may continue. U.S. citizens under exit bans have been harassed and threatened.
U.S. citizens may be detained without access to U.S. consular services or information about their alleged crime. U.S. citizens may be subjected to prolonged interrogations and extended detention for reasons related to “state security.” Security personnel may detain and/or deport U.S. citizens for sending private electronic messages critical of the Chinese government.
Leaving China, IF Possible
Just this morning — like so many mornings before — I got an email from someone asking me “what can I do to determine whether I am under an exit ban?” My response was that I know of no way to determine this short of finding out when you try to leave. What I did not tell this person was that she should have had me assess her China risks before she went to China. See China Exit Bans: You Can Check Out Any Time You Want, But You Can’t Ever Leave.
And if you’ve had enough of China and want out, please know there can be massive risks in leaving China as well. See How to Close Your China Business The Airbnb (Right) Way and How Companies Seeking to Leave China for Mexico Can Mitigate Their Legal Risks and Protect Against New Ones.
What are you seeing out there? How do you protect your company and yourself from China?
