How NOT to Handle Your China Legal Matters, Part 2

Way back in 2006, we wrote a post titled, How NOT to Handle Your China Legal Matters. A friend-client emailed me today saying that he printed it out in 2006 and still gives it to his employees before they have any involvement with China. In his email, he asked whether it needed any updating and suggested we update it on the blog.

So here goes.

I start with that post in full below and then I update that post paragraph by paragraph (further below), with my updates in italics.

There is an expression applied to those who do something particularly unwise in China: “checking one’s brain at the gate.”

I got a call the other day from an American who told me he was owed more than $250,000 by someone in China. The American told me he had given this person in China the money so the two of them could start a business in China together. The Chinese person was now holding on to the money, claiming it as a gift. The American was exploring his options for getting the money back. I asked the American to send me any writings that indicated the purpose of the more than $250,000 he had transferred.  He told me he had no such writings.  He then said that he had been told written agreements were of almost no value in China so he had not bothered with any.

Unfortunately, this is not an isolated example. We are always getting contacted by companies that bought millions of dollars of product from a Chinese manufacturer with no written mention of quality standards. We are aware of American companies that brought their “great idea” to China for production, showed their great idea to a Chinese manufacturer without requiring the signing of any sort of trade secret or confidentiality agreement (NNN Agreement), and then had their great idea stolen from them. We have had calls from companies claiming to be owed millions in commissions from Chinese companies, but without any written commission agreement. We are aware of companies whose former employees have taken nearly all of their China business for lack of any employee trade secret or non-competition agreements. We know of an American company that was blocked from exporting its product from China because someone in China had registered in China the trademark the American company had been using for the last five years.

And the explantions are nearly always the same:

    • “We were told business in China is based on relationships and written contracts would interfere with that and are just not done.”
    • “We just felt we did not have time to do these sorts of things.”
    • “The whole reason we went into China was to save money.”
    • “Nobody told us.”

I thought of all this today after coming across an interesting New York Times article, entitled “Crouching Corruption, Hidden Fraud,” James Ku writes this article in the first person about his stint as the manager of a Shanghai start up company. Mr. Ku writes that he, like “some of the world’s most experienced business people made the mistake of ignoring basic business principles when chasing China’s seemingly limitless potential for profit.”

In addition to my law firm’s China work, we do a ton of legal work for other emerging market countries and I cannot remember a single instance involving a country other than China where someone checked their brains at the gate. I bet nobody woke up this morning and said to themselves, “hey, everybody else is going into Cambodia so I better go there today.” I wish I could say this about China.

Everyone knows China is booming, but everyone should also know it has plenty of risks that require mitigation just like everywhere else. In other words, don’t check your brains at the gate. What do you think?

Paragraph 1. There is an expression applied to those who do something particularly unwise in China: “checking one’s brain at the gate.” We use and hear that expression less these days, but the number of incidences where someone does this have declined, though the negative impact for those who make this mistake have greatly increased. The number of incidents have declined simply because far fewer companies are “going” to China for the first time these days, either for their manufacturing (many are now looking at Thailand, Mexico, Vietnam, Taiwan etc. for this) or for their sales (more are choosing licensing or distribution arrangements instead). But, and as I describe in more detail below, the costs of foreign company China mistakes have increased by so much that I’m guessing the dollar losses are considerably larger today than back in 2006.

Paragraph 2. I got a call the other day from an American who told me he was owed more than $250,000 by someone in China. The American told me he had given this person in China the money so the two of them could start a business in China together. The Chinese person was now holding on to the money, claiming it as a gift. The American was exploring his options for getting the money back. I asked the American to send me any writings that indicated the purpose of the more than $250,000 he had transferred.  He told me he had no such writings. He then said that he had been told written agreements were of almost no value in China so he had not bothered with any. Without a doubt, the most common mistakes we see companies make with China is believing that their Western-style Purchase Order will provide them with any protection from their Chinese manufacturers. Our international litigation team gets around 10 emails every week from companies who paid Chinese manufacturers for product and either never got anything back or got pure crap. There are two ways to prevent these problems. One, conduct due diligence on your product supplier before you send them any money at all and use a manufacturing agreement that actually works for China

Paragraph 3. Unfortunately, this is not an isolated example. We are always getting contacted by companies that bought millions of dollars of product from a Chinese manufacturer with no written mention of quality standards. We are aware of American companies that brought their “great idea” to China for production, showed their great idea to a Chinese manufacturer without requiring the signing of any sort of trade secret or confidentiality agreement (NNN Agreement), and then had their great idea stolen from them. We have had calls from companies claiming to be owed millions in commissions from Chinese companies, but without any written commission agreement. We are aware of companies whose former employees have taken nearly all of their China business for lack of any employee trade secret or non-competition agreements. We know of an American company that was blocked from exporting its product from China because someone in China had registered in China the trademark the American company had been using for the last five years. Our China manufacturing lawyers still constantly get contacted by companies that bought millions of dollars of product from Chinese manufacturers with no mention of quality standards, but usually that is because they have no contract at all. We also constantly get contacted by companies that showed their “great idea” to a Chinese company without first requiring they sign an NNN Agreement and then had that great idea taken from them. This sort of IP “theft” actually went into overdrive about two years ago and it has been accelerating ever since, particularly for companies from countries with rocky relations with China (the United States, Australia, and Canada immediately spring to mind) because Chinese manufacturers believe companies from those countries will jump from China as soon as they can. See How to Give Away Giving Your IP to China Out of Love and China Trademark Theft. It’s Baaaaaack in a Big WayThere are two clear ways to prevent these sort of China IP problems: register your IP (trademarks, copyrights, licensing agreements and/or patents in China) and use a China contract that works, typically a China-centric NNN Agreement. Oh, and one more thing, be very careful about the lawyer/law firm you hire to assist you with your China legal matters because the number of fake, incompetent and/or dishonest “lawyers” who claim to provide China legal assistance has soared since COVID. See China Contract Drafting Scams: From Bad to Much Worse.

Paragraph 4: And the explanations are nearly always the same:

        • “We were told business in China is based on relationships and written contracts would interfere with that and are just not done.”
        • “We just felt we did not have time to do these sorts of things.”
        • “The whole reason we went into China was to save money.”
        • “Nobody told us.”

Interestingly, the explanations have actually changed. Roughly 60 percent of the time the company in trouble says that “we just did not know this” and the other 40 percent of the time they say that they thought the person they hired to help them understood how to protect against China. 

Paragraph 5: I thought of all this today after coming across an interesting New York Times article, entitled “Crouching Corruption, Hidden Fraud,” James Ku writes this article in the first person about his stint as the manager of a Shanghai start up company. Mr. Ku writes that he, like “some of the world’s most experienced business people made the mistake of ignoring basic business principles when chasing China’s seemingly limitless potential for profit.” It is still quite common for companies to fall down on basic business principles. The business mistakes our China lawyers most often see are (1) failing to conduct due diligence on the Chinese company with which they are doing business, (2) trusting everything their Chinese counterpart tells them, (3) not realizing that China is in some respects the same as the rest of the world but in other respects nothing like the rest of the world, and (4) failing to use experienced China professionals to assist them.

Paragraph 6: In addition to my law firm’s China work, we do a ton of legal work for other emerging market countries and I cannot remember a single instance involving a country other than China where someone checked their brains at the gate. I bet nobody woke up this morning and said to themselves, “hey, everybody else is going into Cambodia so I better go there today.” I wish I could say this about China. Even though my law firm’s non-China international work has probably quadrupled since 2006, China still makes up a hugely disproportionate percentage of the major problems we see. Without a doubt this is due to the fact that the Chinese government has set up a system that encourages terrible behavior from its companies. To put it bluntly, if you as a foreign company do not know exactly how to protect yourself from China, you are a sitting duck to Chinese companies that know they can get away with essentially stealing your IP and your money and most of them will not hesitate to do so. In most every other country in the world, the system is less protective of such thefts and its companies are less likely to engage in it.  

What are you seeing out there?