China Product Outsourcing: The Legal Basics

This latest recession has caused more small and medium sized businesses (SMEs) to look to cut costs by outsourcing their product manufacturing to China. Unfortunately, many of these SMEs now engaging in OEM (original equipment manufacturing) outsourcing to China fail to take some or all of the minimal legal steps necessary to protect themselves. When problems arise, they can do little or nothing to protect themselves because they have no legal basis for protection.

China’s legal system for resolving commercial disputes has improved greatly over the past ten years and taking a few basic legal steps can greatly reduce your risk. The cost of such protection is modest compared to the protection it will provide.

The following five basic steps will greatly reduce your problems with Chinese manufacturers, while improving your chances of recovering should any problems arise.

1. Protect your IP where you sell. Create and properly register your intellectual property rights in the United States or whatever country or countries in which you sell the bulk of your products before you go to China. Protect your brand identity by creating and registering your trademark, slogan and/or logo. Register your important copyrights. Carefully identify and protect your trade secrets, proprietary information and know how. Patent what you can.

Doing the above will mean that no matter what happens in China, you should at least be able to protect your product to the fullest extent possible in the country or countries in which you sell your products.

2. Register your trademarks in China. Registration can protect your future access to the Chinese market, prevent the export of counterfeit goods from China, and prevent a competitor from registering your mark in China, which would prohibit you from exporting your own product from China. For more on the necessity of registering your trademark in China, check out China Trademarks — Do You Feel Lucky? Do You? and WHEN To Apply for a  China Trademark.

3. NNN Agreements. Use a China NNN agreement to protect your know-how and trade secrets in China and to prevent your manufacturer from competing with you with your own products. SMEs do not usually have an extensive portfolio of patents. Their most valuable intangible assets typically are their know-how and their trade secrets, which cannot be protected by formal registration. Chinese law, however, permits companies to contractually protect their know how and trade secrets by contract. Such agreements may (and in most cases should) also address issues such as non-competition, non-circumvention and confidentiality. Without such a written agreement, no such protection is available. For more on using China NNN agreements check out China NNN and NDA Agreements.

4. Product Quality and Payment Terms. The rule here is simple. Do not make final payment to your Chinese manufacturer until you are confident you will be getting an on time shipment of the correct items and quantities at the quality standards you require. This usually means you must incur inspection costs in China and have provided a clear procedure for dealing with these problems as they arise. You must take the lead on this; you cannot depend on your Chinese OEM manufacturer to do this for you.

5. Manufacturing Agreements. Use a comprehensive Manufacturing Agreement with each manufacturer. SMEs often enter into OEM manufacturing transactions with a simple purchase order. This is a mistake because the purchase order will not protect you. Your protection depends on your securing a signed and sealed written manufacturing agreement (in Chinese and under Chinese law) with each Chinese manufacturer with which you deal. The ideal China Manufacturing Agreement addresses all of the issues discussed above and various other basic legal issues such as jurisdiction and dispute resolution. This agreement should be in both Chinese and English and its primary language should be Chinese because that is what will control in China.

If you do the above, you will greatly increase the chances of good results from your China product outsourcing. For some more tips on China product outsourcing (including non-legal ones), you should also check out The Seven Keys to Product Quality When Manufacturing Overseas.