Why Not to Overlook China Product Development Agreements
Product development is a crucial stage when manufacturing a new product, but it also carries risks – especially when working with Chinese manufacturers. This article outlines the importance of China Product Development Agreements, the common mistakes foreign companies make with these agreements, and the key provisions your Product Development Agreement should contain to protect your IP rights and prevent project disasters.
China Product Development Agreement are important. And yet, our international manufacturing lawyers often see them not used when they should be used, and also used when they are not needed.
Companies outsourcing manufacturing to China often co-develop products with their Chinese manufacturers. In some cases, the foreign company has completed its product development and the Chinese manufacturer’s only involvement is in setting up to manufacture the product in high volumes. In other cases, the foreign company side has only a general product “idea” and the Chinese manufacturer is tasked with turning the foreign company’s napkin scribblings into a viable commercial product. Sometimes both the Chinese manufacturer and the foreign company contribute technology and know-how, so the final product is a blending of both parties’ contributions.
The Neglected Product Development Stage
The product development stage is the highest risk stage for foreign companies manufacturing in China, yet it is also the stage most neglected by foreign companies. Foreign companies will use NNN Agreements in the factory search stage to protect against the manufacturer using their information to compete against them. They will also will use Manufacturing Agreements to govern the actual production phase after they have selected their manufacturer. But they rarely use Product Development Agreements. This is often a mistake, and this mistake often leads to disaster for the foreign company.
Two Common Disasters for Foreign Companies
1. Losing IP Rights
This disaster usually occurs when Chinese manufacturers perform development work for free, then claim full ownership of the resulting IP. The manufacturer can then dictate unfair terms and prevent the foreign company from using another manufacturer. This happens because foreign companies fail to sign an agreement upfront conferring shared IP rights.
Our China lawyers see this all the time, especially with start-up companies involved in making high tech products. No matter how outrageous the pricing or other demands from the Chinese manufacturer, there is little the foreign company can do because it waited until development was finished before even considering who would end up with “its” IP.
2. Procedural Breakdowns
This disaster stems from foreign companies assuming Chinese manufacturers can develop any product quickly and within budget. In reality, mismatched expectations, and lack of oversight during development often derail projects. Milestones are missed, costs balloon, and final products don’t work as intended. This often leads to the following:
- The product is never completed or never works properly.
- The product is not completed until after the market opportunity has passed.
- The product cost ends up being far higher than projected. And again, Internet of Things companies seem particularly prone to this.
The only good way to address the above product development risks is with a product development agreement enforceable in China. A good product development agreement covers the period between the NNN agreement stage when you are figuring out which Chinese manufacturer to use and the OEM agreement stage when you have already selected your Chinese manufacturer and know exactly what you will have manufactured.
Key Provisions for a China Product Development Agreement
A good Product Development Agreement should usually include provisions addressing the following:
1. The product to be developed.
2. The technology the foreign company and the Chinese manufacturer will contribute.
3. Who will provide the product specifications and in what form.
4. Who will own the IP rights to the resulting product.
Our China attorneys often review product development projects in China where the Chinese manufacturer was asserting it owned all of the IP rights to the developed product. Typically, these Chinese manufacturers were agreeing to make “their” product available to the foreign companies, but they were demanding to be able to manufacture the product for their own sales under their own trademark and to make the product to sell to competitors of the foreign company. Foreign companies are usually stunned when we tell them that because they had no written agreement making clear that they (the foreign company) owned the resulting product, their Chinese manufacturers had legal justification in claiming ownership, since they both contributed technology and incurred all of the product development costs.
5. Who will pay for product development costs?
6. Who will pay for the molds and tooling?
This becomes a major issue when the foreign company seeks to use a different Chinese manufacturer after development of the product is complete. In this situation, the Chinese manufacturer that co-developed the product will likely do one of the following:
a. Refuse to release the molds, tooling, CAD drawings and other items required to manufacture the product.
b. Require the foreign company pay a substantial fee to secure a release of the molds, tooling, CAD drawings and other items related to the product.
c. Claim ownership in the IP related to the product and threaten to sue the foreign company in a Chinese court if anyone else manufactures the product.
The foreign company is particularly badly positioned if its Chinese manufacturer did the development work and produced the molds and tooling at its own cost though it is not at all uncommon for Chinese manufacturers to engage in the above tactics even when the foreign company paid for the molds and tooling. You are not going to be protected from this unless you have a written agreement (enforceable in China) making clear that you own the molds and tooling and penalizing the Chinese manufacturer for not immediately returning those to you. See Manufacturing in China: Control Your Molds.
7. Setting of milestones. Chinese manufacturers often agree to do the development work but fail to do so in a timely manner. Your product development agreement should provide incentives for your Chinese manufacturer to meet milestones and a penalty if it does not. The following is a typical arrangement:
a. The Chinese manufacturer does product development at its own cost, but the foreign company pays all hard costs for molds and similar items.
b. The parties agree on product development milestones .
c. The parties agree on clear specifications.
d. The parties agree on a target price and quantity for when the product is developed.
e. If the Chinese manufacturer meets the milestones and specs and agrees to sell at the target price and quantity, then the foreign company will enter into an OEM agreement with the Chinese manufacturer.
Chinese manufacturers usually prefer to cover all of the costs of product development because they want to own the resulting product and foreign companies far too often go along with this, without realizing this likely means the Chinese manufacturer will end up with the product and its related IP.
Conclusion
When entering the Chinese manufacturing market, the importance of a solid Product Development Agreement can’t be overstated. Think of it as insurance for your product idea. It ensures both you and your Chinese manufacturer know the expectations, roles, and responsibilities from the get-go. Without such an agreement, you risk losing your intellectual property, facing unexpected costs, and having production delays — all of which can harm your business’s bottom line and reputation. For any company looking to turn its idea into a finished product in China, a Product Development Agreement is a necessary safeguard for your hard work, innovation, and investment.
