Our China lawyers have over the last few months have been getting way more emails and phone calls than usual from foreign companies (U.S. and European) telling us they’ve been scammed or seeking our assistance in determining whether they are about to get scammed.
Anyway, in recognition of this recent increase in scamming, we are writing this series on the sorts of scams we usually see, along with providing tips on how to avoid them. This is part 5 of the series. In Part 1, we wrote about the scam of tricking someone to come to China to sign a deal. Part 2 was on the scam of getting money for supplying products and then supplying nothing or, more commonly, something that isn’t even close to what the foreign company bought and paid for. Part 3 was on the switched bank account, which is — by far — the most difficult to avoid scam. Part 4 was on a scam where a Chinese company gets you to provide it work or services (or perhaps even product) in return for stock or stock options that you can never really own because you are a foreigner.
This part 5 involves a fairly recent, increasingly common, and highly sophisticated scam whereby a Chinese company claims to be interested in investing in a foreign company but in reality it has that interest only so far as it can use it to steal your IP. The Chinese company usually starts out by claiming a strong interest in sending over a lot of money in return for a small ownership interest in your company. Many times, the Chinese company will talk about how its investment is not for short term profits, but to help you do an IPO from which everyone will get rich. This all sounds good, but with this comes usually comes something like the following from the Chinese company:
Our company will become one of the owners of your U.S. entity. And since we will be co-owners of the technology underlying your product, there is no reason for you to protect the technology from us. There is no reason to enter into any sort of confidentiality agreement (like an NDA or an NNN Agreement). We do not want legal or financial hurdles to get in the way of the IPO that will make us all wealthy.
So the foreign company provides its technical information to the Chinese company it now sees as its partner and benefactor. In return, the Chinese company starts using your IP and never funds its alleged investment. And for good measure (and to set itself up for a force majeure defense), the Chinese company will often then blame the Chinese government for its inability to get money out of China to fund the investment.
By using this “fake investment” technique, the Chinese company has legally or quasi-legally acquired the technology while paying little or nothing for it and there is nothing the foreign company can do. And it is true that foreign investment from Chinese companies must be approved by the Chinese government. So what is there to say?
On the software side, we usually see the the Chinese company offer to invest a large sum in the foreign company and as part of its grand plan, it will propose to set up a company in China that will eventually be owned by the foreign company. It will then arrange for the software technology to be released to the Chinese entity without restriction. Why should the foreign company spend time and money licensing its software to this Chinese company that it will eventually own a part of in any event. Oh, and this Chinese company will surely be doing an IPO very soon anyway.
In this scheme, there are various delays in getting approval for both the investment in the foreign company and in providing for foreign ownership in the Chinese entity. After two or three years of delay, and after the Chinese company has extracted all of the technology/information it requires, it apologizes for being unable to secure Chinese government approval to invest in the foreign entity and for not being able to give the foreign company any ownership in the Chinese entity because foreign investment in Chinese domestic companies is pretty much prohibited. See yesterday’s post on the China Stock Option Scam.
The end result is the Chinese company acquired the foreign technology virtually free of cost and there is usually nothing the foreign company can do about that.
For another common way in which foreign companies are tricked out of their IP, check out China and The Internet of Things and How to Destroy Your Own Company.