China NNN Agreements: Make Sure Yours Bites

Last week, in China NNN Agreements and How to Give Them Real Teeth, I wrote how important it is to put teeth into your China NNN agreements. But what happens when you do? Our China lawyers have found that properly drafted NNN agreements dramatically reduces infringement by Chinese factories and any litigation relating to these issues.

This is because Chinese companies are genuinely afraid of the Chinese court system. Chinese companies do not fear an order from a Chinese court telling them to behave properly. What they fear is a judgment for a sum certain that a Chinese court will enforce by seizing and auctioning their factory assets. They fear a prejudgment seizure of assets that ties up their factory property until the lawsuit is settled. These Chinese companies know that their breaching a well drafted China-centered NNN Agreement will likely get a Chinese court to freeze their assets and that is the last thing they want.

This fear of China’s court system usually generates one of the following three responses to our NNN agreements by Chinese factories:

1. Some Chinese companies simply refuse to sign.
These are the companies that planned to steal the foreign technology from the very beginning. We recently represented an American company in a very difficult negotiation with a Chinese company on a technology licensing project that involved transferring trade secrets for an industrial process. After unfruitful talks that went on all morning, we reconvened after lunch, at which point the Chinese side announced:  “Look, it is very clear to everyone that the only reason we are interested in this venture is so we can appropriate the technology of the U.S. company. We have reviewed the documents and it is very clear he (pointing to me) will not let us do that. So let’s just stop the discussion right here and admit we have nothing more to discuss.” That was the end of it.

Some U.S. companies would have seen this as a failure of negotiation, but the owner of the U.S. company thanked me. He said his Chinese staff were pushing him into a venture with which he was not comfortable. The confession of actual intent in front of his staff solved his internal problem and stopped his company from making a serious mistake. From this we can see that forcing the hand of the companies that have bad intentions from the start is probably the greatest benefit of a well drafted NNN agreement. I will note though that this sort of situation is pretty rare.

2. Some Chinese companies enter into serious discussion about specific matters they believe should be excluded from the scope of the NNN Agreement.
This means they have read the NNN Agreement and they take it seriously, and because they take it seriously they insist it be modified to reflect their own realities. In some cases, the Chinese company’s concerns are unfounded. But, in other cases, the Chinese company will reveal they already have technology of their own in the same area that they need to protect.

This is a positive result, for several reasons. First, if the concerns of the Chinese company are unfounded, this provides advance notice that the factory will be unreasonable and difficult to deal with. Second, if the concerns are reasonable, this provides the grounds for more fruitful discussions on each party’s technical concerns and these discussions often lead to more fruitful joint development of existing technology. In the past, U.S. and European companies simply assumed the Chinese factory was without any technical base of their own. This is no longer true and so it is often now necessary to consider the technical base of both sides in any project involving new technology in China.

3. Most Chinese companies execute the NNN agreement and then treat the three obligations as a serious matter that must be approached with care.
This is by far the most common situation and I estimate this counts for at least 95% of the situations our China lawyers face.

How does this work out in practice? It does not mean every Chinese company will suddenly abandon years of bad practice and begin behaving well. What it does mean is that when the Chinese factory violates the rules, litigation is usually not required. In most cases, a reference to the NNN agreement and the credible threat of litigation is enough to induce the factory to reform its behavior and step back into line. This is particularly true in cases of disclosure to undisclosed third parties and to attempts at circumvention.

This then illustrates the general approach my firm’s China lawyers take with agreements in China. We do not want to litigate nor do we intend to litigate. Rather, we use the general fear of litigation and involvement with the courts to achieve a result that greatly reduces the likelihood of ever having to go to court. But to be able to reduce the likelihood of having to go to court it is essential the Chinese side believe it would be relatively easy for you to sue it and prevail. Most importantly, the Chinese side must believe you can quickly and easily get a Chinese court to freeze its assets. If the threat of an enforceable money judgment in a Chinese court is not credible, this strategy does not work. Chinese companies are experts at seeing through threats that are mere bluffs. So the foreign company needs to do its NNN Agreement correctly. Teeth are not enough. You have to make the agreement bite.

For more on China NNN Agreements, I suggest you read the following, in order: