How NOT to Lose Your Shirt When Having Your Product Made Overseas

China Lawyers for Manufacturing Contracts

When a company comes to us looking to have its product outsourced for manufacturing in a foreign country, they often do not have a fully final product. By this I mean their “product” can be a mere idea,  a prototype needing further development before large scale manufacturing, a product needing minor refinements, or a fully-fledged ready-to-go product. Our international manufacturing lawyers deal with less than fully-fledged products more than half the time.

Often, a client will believe its product is “ready to go” when it actually can (and should be) further modified to reduce production costs or make it a little bit better. It is quite common for good overseas manufacturers to suggest helpful changes to so-called final products.

Whenever an overseas manufacturer modifies (even slightly) one of our client’s products (and even when they don’t), our international manufacturing lawyers initially have the following three questions:

  1. Will our client own the IP rights to the modifications?
  2. Will our client own the IP rights to the final product?
  3. How can we as the lawyers best protect our client’s IP rights in the modifications and the products?

These are not merely academic questions as our international IP lawyers get a fairly steady stream of American (United States, Canada, Brazil and Mexico, mostly), Australian, and European companies seeking help to “recover” their IP rights taken by their (mostly) Asian manufacturers. Much of the time there is little our IP lawyers can do in these situations either because it is not clear who owns the IP rights or it is clear our client unintentionally relinquished the IP rights to its manufacturer. Even worse, there are times where we have to tell our client it is not clear who would prevail were we to bring a lawsuit but it is clear such a lawsuit will be incredibly time-consuming and expensive and require all sorts of highly paid experts.

Do you know who owns the IP rights in the products you are buying from overseas? It is not uncommon for overseas manufacturers to wait years before asserting their rights to “your” product. This assertion usually comes when your manufacturer decides the time has become right for it to begin selling its own products or when you decide you want to use another manufacturer. See Your China Factory as your Toughest Competitor and How to Stop Your China Manufacturer from Selling Your Product to Others for how common the first of these scenarios has become and see Why Changing Suppliers Can Be So Risky for how common the second of these scenarios has always been.

1. Product Development Agreements

The product development stage is the highest risk stage for foreign companies manufacturing overseas and yet also the most neglected. Foreign companies will use NNN agreements in the factory search stage and Manufacturing Agreements (ODM, CM and OEM) for the production stage, but they rarely use Product Development Agreements during the product development phase, often because they do not recognize they are in that stage or because they believe their NNN Agreement will protect them.

Foreign companies often mistakenly assume their overseas manufacturers can develop any product within the tight timeframes and close tolerances required by modern business. This often leads to the following problems:

  • The product is never completed or never works properly.
  • The product is not completed until after the market opportunity has passed.
  • The product ends up costing far more than anticipated.

The best way to address the above product development risks is with a product specific product development agreement tailored to the country in which your manufacturer is located. A good product development agreement covers the period between the NNN agreement stage when you are figuring out which manufacturer to use and the Manufacturing Agreement stage when you have already selected your manufacturer and know exactly what you will have manufactured and covers the following:

1. The product to be developed.

2. The specific technology the foreign company and the overseas manufacturer will contribute.

3. Who will provide product specifications and in what form.

4. Who will own the IP rights to the resulting product. Our international manufacturing attorneys often review overseas product development projects where the overseas manufacturer has asserted it owns all the IP rights in the developed product. These overseas manufacturers typically had agreed to make “their” product available to our clients  while at the same time manufacturing the product under their own trademark and for sales to competitors of our client. Our clients are usually stunned when we tell them that because they had no written agreement making clear they would own the resulting product and the resulting IP in that product, their overseas manufacturers are legally justified in claiming IP ownership because they contributed their technology to developing the product and incurred 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 manufacturer after product development is complete. In this situation, the overseas manufacturer that helped you to develop 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 you pay a substantial fee to give you 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 you in its own country if anyone else manufactures the product.

You will be particularly badly positioned if your overseas manufacturer did the development work and produced the molds and tooling at its own cost, though it is also common for overseas manufacturers to engage in the above tactics even when you paid for the molds and tooling. You are not going to be protected from this unless you have a written agreement (enforceable in your manufacturer’s country) making clear you own the molds and tooling and penalizing the overseas manufacturer for not immediately returning those to you. See Product Molds And Tooling Three Things You Must Do to Hang on to Yours.

7. Setting milestones. Overseas manufacturers will often agree to do your development work but then fail to do so in a timely manner. Your product development agreement should provide incentives for your overseas manufacturer to meet the listed milestones and a penalty if it does not. The following is a typical arrangement:

a. The overseas manufacturer does product development at its own cost and you pay all hard costs for molds and similar items.

b. Milestones and clear specifications for product development are set.

d. You and your overseas manufacturer agree on a target price and quantity for when the product is developed.

e. If your overseas manufacturer meets the milestones and specs and agrees to sell at the target price and quantity, you will then enter into a Manufacturing Agreement with it.

Overseas manufacturers (especially in China and especially in Chinese-owned factories in Vietnam and Thailand) usually prefer to cover all product development costs because they want to own the resulting product and foreign companies far too often go along with this, without realizing this likely means your overseas manufacturer will end up with “your” product and its related IP.

2. How to Protect your Molds and Tooling when Manufacturing Overseas

I am right now in the midst of an email exchange with a Spanish company that started with that company wanting our international manufacturing lawyers to review an NNN Agreement and a Mold Ownership Agreement it had paid a Chinese law firm to draft. This company was having a “bad feeling” about the documents and wanted my law firm’s international manufacturing lawyers to make sure they “would work for China” before submitting them to its longstanding Chinese manufacturer, with which it had maintained a “superb” relationship for the last seven years. I very quickly looked at the contracts — they were probably passable — but immediately wrote back to the company to ask whether it had a Manufacturing Agreement with this Chinese manufacturer. The response from the Spanish company was essentially, “no, but why?”

The why is that a Manufacturing Agreement is exactly what this company needed and it could have saved time and money and even credibility with its Chinese manufacturer by getting it. I explained that due to the stage it was in with its Chinese manufacturer, it would have been faster, cheaper and way better for it to have had its Chinese law firm draft a Manufacturing Agreement with its Chinese manufacturer that included a paragraph with NNN provisions and another paragraph simply making clear the Spanish company owned the listed molds.

That very recently concluded email exchange got me to thinking of how incredibly common it is for companies to come to us after having spent good money for legal things they either did not need at all or barely needed, especially in comparison to what they truly did need. We see this sort of overbuying/overselling by law firms all the time. Just last week, I consulted with a company that came to us after having paid for four trademarks in China when it clearly only needed one trademark. I also spoke with a company that had paid for a China employment contract even though it had no Chinese entity, which is one of the most dangerous things any foreign company can do. See American Companies in China without a WFOE and the Impact of Donald Trump and US Tariffs and Why Hong Kong is not the Answer.

Pretty much every day, a client or a potential client will come to one of the attorneys at my law firm — and this holds true for every area of law in which we practice, not just international law — saying it wants to retain us for X when the client actually needs Y. Needless to say, our attorney never would say, “sure, I will charge you for Y and do Y,” while all the while thinking “this client really needs X.” No. She would say, “wait a second,” what you need here is not Y, but X, and let me explain why this is so. Unfortunately, many Chinese lawyers in China have been trained differently and I talked about this in an interview I gave back in 2016. See On Being a China Lawyer and on Doing Business In China: An Interview):

I’ll backtrack a little and tell you the problems American companies often have with Chinese lawyers.

An American company will hire a Chinese lawyer and tell the Chinese lawyer, “I want to do ‘A,’” and the Chinese lawyer will do “A.”

Three months later the American company will learn that no one’s doing “A” anymore. They’re all doing “B.” So it will go back to the Chinese lawyer and say, “Look, we did ‘A.’ Now everyone’s telling me that wasn’t a good idea.” The Chinese lawyer will then say, “Right, it was not a good idea.”

“Then why did we do ‘A’?”

“Because you told me to do ‘A.’”

It drives American companies nuts. If you had called up an American lawyer, he or she would have said, “Why do you want to do ‘A’? We do ‘B’ 99% of the time. Let’s talk about it.” When somebody tells me they want to do something, I don’t just say, “Yes.” I ask them 10 questions because I want to make sure that’s the right way to go.

The typical dynamic between Chinese companies and Chinese lawyers is, “I’m the boss. You’re my scrivener.”

One time we were brought in to help a Chinese company. Twenty years ago it had formed an American company, and then that American company had formed a Chinese company. It’s called a “roundtripper.” China once gave all sorts of preferences to foreign companies; Chinese nationals would form American companies, then go back to China to get the preferences. Not legal, but it was very common.

This Chinese company had gotten huge. They had a company in the United States that was formed by somebody’s cousin, had never paid taxes, and maybe had aspirations of going public. They needed to clean up their act. It was hugely complicated, and we brought in an international accounting firm to help on the tax side.

My colleague Steve Dickinson is based in China, and one of the lawyers we work with there invites him out to lunch. Steve is thinking, “That’s weird. This lawyer never invites me to lunch.” Steve goes to the lunch and the client’s there, and the client has this idea on how to solve the problem in about 1/10 the time and at about 1/100 the cost of what we have said needs to be done.

Steve tells the client (nicely, I presume), “Are you kidding me? You know nothing about U.S. laws, you know nothing about U.S. taxes, you’re not a lawyer or an accountant in China, and you think you’ve just solved the problem? Give me a break.” Why was Steve brought to this lunch? Because the Chinese lawyer knew it was absurd, but he just was not comfortable telling this to his client because that is not his role.

When Chinese companies come over here to the United States, they often want to tell us exactly what to do. Once we took on a case where as soon as we were paid, the Chinese company told us how we were going to handle it. We told them that what they were asking us to do would be the dumbest thing we could possibly do. (I talked with about 10 other lawyers and they were like, “Seriously?”)

“No, we need you to do that,” the Chinese company said.

We responded, “Nope. Here’s your money back.”

As lawyers, we can’t have that. Our reputations are on the line. We’re not going to do something that makes us look silly and just wastes the client’s time and money. We’ll do things for clients even if we disagree, but not when it’s absurd or unethical.

What does the above have to do with saving your shirt when manufacturing overseas? A ton, because one of the ways you save your shirt is by getting all the manufacturing contracts and protections you need and no more.
The below is a typical email I send in response to companies that write us saying they need legal help with their overseas manufacturing and asking how we would propose to provide them with that help.

Working with our international manufacturing lawyers will in the end always depend on what makes sense for your company and your product, but to give you at least some idea of what we do, I can tell you that we usually do some combination of the following for our clients that are looking to have their products manufactured overseas:

NNN/NDA Agreements. We almost always do these in the language of the country of your manufacturer (the official version) and in English (for you) and they typically take us 4-5 business days to complete. You can learn more about our NNN Agreements here. We draft our NNN Agreements to protect confidentiality and to prevent your overseas manufacturer from competing with you or circumventing you. They make sense before you reveal any confidences. If you choose to have us draft an NNN Agreement, we first send you a one page Flat Fee Agreement setting out the fee structure. We next send you a questionnaire and when we have your answers to that we draft the NNN in English for your approval. Once you approve of the English language version, one of our lawyers will then re-write that into the official language and we then send that to you. You then send the full NNN Agreement to your overseas counter-party and if it proposes any changes we will revise it.

Manufacturing Agreements. Once you have chosen your overseas manufacturer, you need a Manufacturing Agreement (a/k/a OEM Agreement or Product Supply Agreement) in the language of the country of your overseas manufacturer (official) and in English (for you). These typically take us 10-14 days to complete. You can find out more about our Manufacturing Agreements here. Our drafting process for these agreements is similar to our drafting process for our NNN Agreements. If you are already certain who you will be using as your overseas manufacturer you can probably skip the NNN Agreement and go straight to the Manufacturing Agreement as our Manufacturing Agreements contain all the substantive provisions of our NNN Agreements.

Trademarks. If you plan to put your company name or your brand name or your product name or your logo on your product or on its packaging, you need to register those as trademarks in the country in which you will be having your product made (there are some exceptions to this which we can discuss when you are clearer on where you will be doing your manufacturing). This is usually true even if you will not be selling your product in the country where your products will be made. Our trademark fees vary by the country. It also generally makes sense for you to have a trademark in those countries in which you have or expect to have substantial sales and we can help you with that also. It also sometimes makes sense to secure patents or copyrights as well.

In addition to the above (each of which depends on your situation and/or your product) and depending on how your production progresses, there may be other agreements necessary. If you want help finding the right factory, we can help with that also, either with our own people or by referring you to outside sourcing experts.

Our goal is to provide our clients with customized solutions to fit their manufacturing needs. Towards that end, if you have any additional questions, please do not hesitate. In the meantime, if you can tell us more about your product, your situation, and your goals, we can help narrow down your actual needs. At some point we would be happy to get on the phone with you because in 10-15 minutes of my peppering you with questions I am confident we can figure out exactly what you need.

When manufacturing overseas, what makes sense for you is what makes sense for YOU and that is not usually going to be what you read on the internet nor what some other company tells you it did nor what you tell some law firm you need nor what some law firm wants to sell you.

3. Product Samples are not Going to Help You

I did an interview for Global Sources the other day focused on getting a product sample before you buy. This interview is titled, Expert talk part 3, Dan Harris: Buy samples, cover all the bases and its preface notes how a “common thread” with my two previous interviewees was that “product samples can spell the difference between a successful sourcing journey and an importing disaster.” It then gives the following quotes from the two previous interviewees:

  • As John Niggl put it, “Buyers who skip the product sampling stage do so at their own peril. The benefit that comes from being able to “try before you buy”—review and approve a sample before committing to an order—is simply too great.”
  • Gary Huang, meanwhile, underscored the importance of product samples by comparing it to an audition where you can get a glimpse of quality and capability.

Well I’m here to tell you somewhat the opposite. Product samples are overrated. Sort of.
I am not going to deny that product samples are valuable and I am not going to tell you not to get product samples because product samples are indeed valuable and you should get them. But, from a legal perspective, they can be both highly risky in terms of your IP and worthless in terms of protecting you from bad quality.
Let me explain via the interview, with the interview questions in italics and my answers in normal font (modified slightly to enhance your reading pleasure)

Global Sources: What’s your take on buying product samples from overseas? What are the challenges?

Dan Harris: As a lawyer, three things always scare me about foreign companies having a sample made by an overseas factory:

First, does the foreign company have an enforceable agreement that will stop the overseas factory from copying the foreign company’s product and selling it around the world?

Second, did the foreign company apply for a trademark in the manufacturer’s country (China, Vietnam, Thailand, Mexico, Indonesia, etc.) before it revealed its brand name to its manufacturer? This is critical because the first to apply for a trademark in most countries gets it, regardless of whether the foreign company previously registered its trademark in its home country. See e.g., China Trademarks: Register Yours BEFORE You Do ANYTHING Else.

Third, many foreign companies just assume that if they get a good sample the products will match the sample and if they do not, they will be legally protected. Neither of these are true, though.

Global Sources: Do you have a story of sample orders gone wrong?

Dan Harris: Our manufacturing team have definitely seen nightmare scenarios. The most common is when a foreign company has an overseas factory make the molds and make the sample and then learns that the overseas factory is using the molds for itself and selling the product to competitors of the foreign company or direct to consumers.

Often when this happens (surprise, surprise), the overseas factory is also supplying bad quality products to the foreign company. This way the overseas company can not only sell the foreign company’s own products, it can sell better quality products than the foreign company.

Global Sources: Despite these challenges, what benefit do buyers get out of product samples?

Dan Harris: You can use samples to determine whether the factory is capable of meeting your quality standards. The problem is that one factory might have another factory make your sample and then pass it off as its own. This is particularly common in China where factories are so often clustered by product. Foreign company buyers should be certain to protect their IP by using an enforceable NNN Agreement and by seeking to register their company name, brand name and logos in the country in which their manufacturer is located and they should do this before they reveal any of those to anyone overseas. And if you are going to legally obligate your overseas factory to make your products to the specifications of your initial sample, you need an enforceable written contract mandating that it do so.

Global Sources: A buyer gets samples from three or more manufacturers. All samples meet his requirements and he’s satisfied with quality? Which manufacturer does he work with?

Dan Harris: I am a big believer in having the client visit the factory and meet with the people in person. This usually tells you a lot.

Global Sources: How can Harris Bricken [my law firm] help buyers with the sample order stage?

Dan Harris: We help with the contracts and the IP registrations. I have to note that the biggest change we have been seeing from our clients in terms of buying products from overseas is that they very much want to start buying from countries in Asia beyond China (such as Vietnam and Thailand and Indonesia and the Philipines) and from Eastern Europe and Latin America.

Product Samples can be great for determining whether an overseas factory has the capability to make your product at the quality you want, so long as the product sample you are given actually comes from the particular overseas factory with which you are dealing. But just getting the sample has its IP and other risks against which you should be protected.

Now go forth and prosper.

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