China and the Internet of Things and What NOT to Do

I had essentially the same call recently with two different European (one French, one Spanish) IoT start-up companies that might at this point better be termed “wind-down” companies.

Their stories are an old one, and one we have covered and warned about at least a dozen times on here, including in a post directed specifically at Internet of Things companies, entitled,  China and The Internet of Things and How to Destroy Your Own Company. These two companies either did not read that post or they failed to take it seriously.

To make a long story short, these two companies were working with Chinese companies to produce two internet of things devices and both companies eventually succeeded. Problem is that when they did, the Chinese companies essentially told them “adios” (I am right now in the Madrid airport, hence my use of Spanish) and left these two European companies with pretty much nothing at all.

To make a long story short, these two companies were working with Chinese companies to produce IoT devices and both companies eventually succeeded with their products. Sort of.

I am going to digress a bit here, so please bear with me. One of my favorite poems is called “beware:” do not read this poem, by Ishmael Reed and that poem nicely encapsulates what happened with these two European companies. Here is that poem and below that, I explain the connections. Enjoy.

tonite, thriller was
abt an ol woman , so vain she
surrounded herself w/
many mirrors
it got so bad that finally she
locked herself indoors & her
whole life became the
one day the villagers broke
into her house , but she was too
swift for them . she disappeared
into a mirror
each tenant who bought the house
after that , lost a loved one to
the ol woman in the mirror :
first a little girl
then a young woman
then the young woman/s husband
the hunger of this poem is legendary
it has taken in many victims
back off from this poem
it has drawn in yr feet
back off from this poem
it has drawn in yr legs
back off from this poem
it is a greedy mirror
you are into the poem . from
the waist down
nobody can hear you can they ?
this poem has had you up to here
this poem aint got no manners
you cant call out frm this poem
relax now & go w/ this poem
move & roll on to this poem
do not resist this poem
this poem has yr eyes
this poem has his head
this poem has his arms
this poem has his fingers
this poem has his fingertips
this poem is the reader & the
reader this poem
statistic : the us bureau of missing persons re-
ports that in 1968 over 100,000 people
disappeared leaving no solid clues
nor trace only
a space in the lives of their friends

I cite to this poem because I am desperate to get people to stop essentially losing their companies to their Chinese counterparts and I figure listing out a full poem and then analyzing it will help people remember. I will admit to being desperate here and just plain tired of having to pass on horrible news to what once were up-and-coming start-up companies.

Just as the woman in the poem gets so enamored with herself that she loses her existence, these two companies became so enamored with their technology and their work on their technology, they too lost their existence. The woman was swallowed by the poem and the European companies were swallowed by the Chinese companies with which they worked. Neither the woman nor the European companies really thought about what they are doing until it was too late. Not until the Chinese company had taken the

European companies’ figurative head, arms, fingers, and fingertips did it think about what it had done. But by that point, they had essentially ceased to exist.

The final paragraph of the poem describes what happens every day to tech companies that go into China unprepared. Their attempts to fuel their dreams destroy their reality. They disappear, “leaving no solid clues nor trace only a space in the lives of their friends.”

Let us now return to the facts and discuss some relatively easy solutions.

Both these European companies had what they saw as great ideas and both started working with Chinese companies to realize those ideas. One company worked with its Chinese “partner” for more than a year. The other for about a year. Both companies seem to be (have been?) made up of 2-4 people who had dedicated the last few years to getting their devices off the ground and to market. Yet right before their products became ready to launch, their Chinese factories jettisoned them and chose to go it alone with the European companies’ devices.

The European companies wanted to know whether the international dispute resolution lawyers at my law firm could help them. I told them this was “both doubtful AND expensive.”

Technology companies dealing with China tend to make more and bigger mistakes than companies in other industries. The ethos of tech companies is to focus on building things (be it software or hardware or some combination of both) as quickly as possible, and not worry much about anything else. In an effort to preserve oftentimes limited funds, tech companies tend to be reluctant to spend money on anything (including legal fees) that does not directly help them develop their product and get it to market. I completely understand this, including how this usually makes sense when operating purely domestically in the United States and in Europe. But this way of doing business is often disastrous when dealing with China, where it is usually impossible to “fill in” a legal foundation later.

Internet of Things companies are the new poster children for how to operate incorrectly when doing business with China. I think this is because they are both tech companies and mostly new to international manufacturing.

I say this with regret because our China attorneys LOVE Internet of Things companies. We love IoT companies because we so often love and use their products and because the work we do for them is typically cutting-edge and interesting. IoT companies looking to manufacture in China often require assistance with the following:

  • Technology Licensing Agreements. Many of the most complicated and cutting-edge licensing agreements we do have been for IoT companies. IoT devices are usually chockfull of new hardware and software technology and those technologies are usually owned by many companies from many different countries.
  • Worldwide IP Registrations. IoT devices often implicate copyrights, trademarks, and patents, and oftentimes all sorts of product ownership and product development rights issues involving multiple parties in multiple countries. We often help our IoT c clients formulate a worldwide IP strategy as so many of them have feet in Asia, Europe, and the United States or Canada or Australia.
  • China Manufacturing Contracts. Our China manufacturing clients almost always need an NNN Agreement and then a Contract Manufacturing Agreement, but that is usually it. It is not uncommon for our IoT clients to need a Product Development Agreement, a Product Ownership Agreement, a Mold Ownership Agreement, along with the usual NNN and Contract Manufacturing Agreement. This is because both the product itself and the product development process are often so complicated.
  • We also often work with our IoT companies on legal and timing matters related to their Kickstarter or Indiegogo campaigns.

If you need more proof of how much our China lawyers love IoT companies, check out China and the Internet of Things: A Love Story.

But back to the sad part. What is so terrible is that IoT companies seem to relinquish their intellectual property to Chinese companies more often, more wantonly, and more destructively than companies in any other industry I (or any of my firm’s other China IP lawyers) have seen. Ever, and by a stunningly wide margin. And the thing is, it is not as though these are big companies with a whole host of other products or IP they can turn to in a storm. No. Most of these IoT companies shrivel up and die after their IP goes “poof” in China.

In describing IoT companies and their problems to others, The following interaction, taken from at least a half-dozen real-life examples in just the last few months (and the last few months before that and the last few months before that) should be at least somewhat instructive:

IoT Company: We just completed our Kickstarter (sometimes Indiegogo) campaign and we totally killed it and so now we are ready to get serious about protecting our IP in China.

One of our China Lawyers: Great. Where are you right now with China?

IoT Company: We have been working with a great company in Shenzhen. Together we are working on wrapping up the product and it should be ready in a few months.

China Lawyer: Okay. Do you have any sort of agreement with this Chinese company regarding your IP or production costs or anything else?

IoT Company: We have an MOU (Memorandum of Understanding) that talks about how we will cooperate. They’ve really been great. They told us they would enter into a contract with us whenever we are ready.

China Lawyer: Can you please send us the MOU? Have you talked about what your contract with the Chinese company will actually say?

IoT Company: Sure, we can send the MOU. It’s one page. We haven’t really talked much about the contract beyond the obvious and what we need to do to get the product completed.

China Lawyer: Okay, we will look at your MOU and then get back to you with our thoughts.

Then, a few days later a conversation like the following ensues:

China Lawyer: We looked at your “MOU” and we think there is a good chance a Chinese court would view that MOU as a contract. For why we say this, check out Beware Of Being Burned By The China MOU/LOI. And the Chinese language portion of the MOU (which is all a Chinese court will consider) is different from the English language portion. The Chinese language portion says that any IP the two of you develop (the IoT company and the Chinese manufacturer) belongs to the Chinese company. So as things now stand, there is a good chance the Chinese company owns your IP, at least in China. Therefore, there is no point in our writing a Product Development Agreement because your Chinese manufacturer will almost certainly not sign that.

IoT Company: I’m not worried. I think you have it wrong. I’m sure they will sign such an agreement because we orally agreed on this before we even started the project. (We get some sort of variation on this response at least 90 percent of the time).

China Lawyer: That’s fine, but I still think it makes sense for you to first make sure the Chinese company will sign a new contract making clear the IP associated with your product belongs to you, because if they won’t sign something saying that, there is no point in our drafting such a contract and, most importantly, there is no point in your paying us to do so.

So far not a single such IoT company has come back to us saying their Chinese manufacturer actually truly agreed to sign such an agreement. Not one.

The situation with the two European companies has also become par for the course. In this situation, the IoT company is farther along in its product development and actually ready to sell what it perceives to be its product. This situation is exemplified by the email below, which is an amalgamation of various emails received by my law firm:

I am hoping your firm can help us figure out the best course of action going forward. [A description of their company and their IoT product then follows, along with how they ended up going with a particular Chinese manufacturer and why they failed to seek out the advice of a China lawyer until now. This description too often involves their domestic attorney having said he or she would turn them over to a “China specialist” as soon as that “becomes necessary.”]

We do not have any contracts in place with our current manufacturer. We started our relationship with our current manufacturer a year ago. He told us that POs are contracts in China and our lawyer confirmed that. We sent our Chinese contract our design and we paid for the molds and he shipped us the products. We recently learned that he has been using our product pictures as marketing material on Alibaba and selling our products all over the world. I also just learned that he has filed for a design patent for our design in China.

When I confronted him about this he basically admitted to everything but essentially said he had no intention of changing and if we go to a new factory to try to make our product, he will shut that down.

We’re filing design patents in the US. If we continue to work with him during this period, which agreement would help us get the best protection?

Since he already claimed our designs in China, will that prevent us from working with a new manufacturer? Do you advise we work with a new manufacturer at this point?

Our law firm’s response is usually something like the following:

A PO is not really a contract in China; it is the placing of an order. Unless your PO speaks to IP (which would be unusual), it probably will not help us much. On top of this, some Chinese courts do not see POs as a contract at all and some Chinese courts will not even look at a document not in Chinese. The ideal is a Chinese language contract sealed by the Chinese company.

Our biggest concern is that this manufacturer has filed for a design patent for your product. This will no doubt pose problems for you and for any new Chinese manufacturer you might seek to use. Depending on how far along your present manufacturer is in the patent process, it may be able to sue you and your Chinese manufacturer for patent infringement damages and to force production of your product to cease. At a minimum, your Chinese manufacturer will be able to cause you all sorts of problems unless you can stop or invalidate his design patent. There is a good chance this Chinese manufacturer “owns” your product in China and it can use that ownership to control what you do there.

If you seek to go to a new manufacturer you can be pretty sure your old manufacturer will NOT give you the molds you think you bought from it and it will use its design patent to try to block your products from leaving China. It also very well may sue you for patent infringement in a Chinese court. In the meantime, making your product in China will be a high-risk proposition.

Did you register your company or brand name or logo as China trademarks? If not, there is a good chance your Chinese manufacturer registered those as well, but for various reasons under the name of what appears to be an unrelated company. If it did that, it will probably be able to stop anyone from making your products in China with “your” company, brand name or logo on them or on its packaging. No matter what else you do, you should consider retaining us right away to see whether it is not too late for us to secure key China trademarks for you. I urge you to read this on China trademarks.

We usually (but certainly not always!) end up advising these IoT companies to seek to do some combination of the following, none of which are great ways to go and some of which do not work at all for some companies:

1. Leave China entirely and start manufacturing in some other country.

2. Seek to block or invalidate the Chinese manufacturer’s design patent.

3. Try to strike some sort of deal with the Chinese manufacturer whereby the Chinese manufacturer assigns the patent(s) and trademarks to our client who in return agrees to keep using that Chinese manufacturer to make x amount of product for x number of years.

4. Try to get the Chinese manufacturer to sign a contract that makes clear what IP belongs to our client and makes clear the Chinese manufacturer’s limitations on using our client’s IP. We typically do this with a China-centric OEM Agreement.

5. Go to a new manufacturer in China. If you do this, you almost certainly will not have your molds and there is a good chance your existing manufacturer will cause you a lot of trouble by suing or threatening the new manufacturer.

Don’t let the above happen to you. For more on how you can prevent this, you should, at a minimum, read and heed China NNN Agreements and China Product Development Agreements. NOW!