In working with outsource manufacturing in China, our international manufacturing lawyers often advocate drafting contracts that make clear the foreign product buyer owns the product molds. To accomplish this, our China manufacturing lawyers concentrate on two issues when drafting mold provisions that are part of a larger contract (such as a manufacturing agreement or a product development agreement) or that essentially stand alone as part of a mold ownership contract.
First, we want to make clear the Chinese factory can use the molds only for producing our client’s product and not for producing for any other party. Second, we want it clear that when our client chooses to move its production to a different factory, it will have the right to take possession of the molds and transport them to the new manufacturing location. Negotiation of these terms is usually quite difficult, since the Chinese manufacturer has a strong incentive to hold molds “hostage” so as to prevent the foreign buyer from moving its manufacturing to a new factory. The only way to succeed is with a stand alone mold ownership agreement or well-crafted mold ownership provisions inserted into a written manufacturing agreement.
As manufacturing in China has become more complex, molds for products have become correspondingly more complex as well. In many cases, the mold embodies most or all of the intellectual property in the product. I can give two examples. First, in some products, the interior mechanism is based entirely on open source hardware. The external enclosure surrounding the mechanism is therefore the primary protectable IP for the product. The IP resides entirely in the molds used to manufacture the product case. The”look and feel” of the enclosure then becomes the identity of the product, and If that “look and feel” is not protected, the foreign designer owns nothing at all in the IP of the product. Without the IP in the molds protected, Chinese factories can freely copy the product.
Second, in some products, the form embodied in the mold is in fact the entire value of the product. Take for example a complex part used in the manufacture of a turbine or jet engine. After all the engineering and testing is complete, what remains? What remains is a single part produced by casting into one or more molds. In this situation, the molds embody the entire intellectual property in that part. and thus the party that owns or controls the intellectual property in the molds is essentially in complete control of the product. More importantly, if no party owns any IP in the molds, the molds are effectively open source, and no one owns any IP in the molds or the product.
Chinese factories have figured this out, making protection of molds much more difficult. In figuring out what to put into our clients’ contractual mold provisions, our China manufacturing attorneys can no longer focus solely on the issue of ownership; we now also must focus on ownership of the intellectual property in the molds as well.
IP issues when dealing with third party mold fabricators
The issues that typically arise with mold fabrication shops arise because of a change in procedure that no one has really noticed. It is standard procedure to provide that the Chinese factory that is making your product is responsible for fabricating the molds for the product. In the old days, the same factory almost always made the molds and the product. However, it has now become more common for the factory to outsource mold fabrication to a third party. In many cases, even the design of the molds is outsourced to that third party.
What this means is that a mold agreement with your factory that has been drafted to control the ownership of the molds and to control the IP in the product is compromised or eliminated when all of the specifications and the responsibility for fabrication gets sent off to a third party mold manufacturer. Given the economics of mold fabrication in China, it is not likely that the mold fabricator will use the mold design for its own purposes. Rather, the fundamental risk here is that the mold manufacturer will sell copies of the molds to other Chinese factories who have an interest in cloning your product.
This type of cloning is of course a thriving business in China. Foreign designers often wonder how a terrific copy of their product got to market before they have even gone into full scale production. Well this is how it happens: the mold manufacturers conduct a thriving trade in selling the “latest” molds. Though it is common to blame the factories for this leakage, this blame is often misplaced. Your China factory has an incentive to keep the mold for its own use since once the mold gets out into the world, the molds are then used by your factory’s competitors. When this happens, the Chinese factory is damaged in much the same way as the foreign designer.
Though losing one’s molds via a third party mold fabrication shop is an enormous risk, few foreign designers and virtually no Chinese factories make much to control the mold fabricator. In other words, clearly drafted written contracts dealing with this issue are rarely entered into between the Chinese factory and the mold fabricator. The foreign designer not only hardly ever enters into any sort of contract with the mold fabricator, the foreign designer normally does not even know the identity of the fabricator. This leaves a gigantic hole in IP protection. This hole can and should be closed through a simple set of contracts.
Consider also what this uncontrolled release of the design of the product means in terms of intellectual property in the product. Many products designs are protected primarily as trade secrets. When the design is released to a third party fabrication shop with no written agreement, the secrecy in that product is broken, and this eliminates any trade secrecy protection.
Consider also the issue of patent protection. In acquiring a patent anywhere in the world, one of the first questions that has to be answered is who invented the item. In a case where the design of the mold has been outsourced to a third party fab shop, the question of who is actually the inventor is now unclear. Is it the foreign designer who developed the basic idea? Is it the Chinese factory that did some preliminary drawings? Or is it the mold fabricator that did the detailed drawings and produced the final working model? Or is it all three, each entitled to an uncertain percentage of the patent?
With this sort of tripartite structure, the usual answer is that no one owns any IP in the molds: no patents, no trade secrets. Often that then means that no one owns any IP in the product itself. This obviously then leads to disaster in the commercialization phase for the product.
Current Issues with China Molds
The below are the sorts of issues our China lawyers have been seeing lately with Chinese manufacturers on mold issues.
The Chinese manufacturer has produced a series of molds for a product for its foreign buyer. Now that the product has become commercially successful, we often see the following three basic problems arise:
- The Chinese manufacturer announces a substantial increase in the price of the product. This is often a surprise to the foreign buyer, who had expected the per unit price of the product to go down as production increased.
- The Chinese manufacturer is not able to keep up with increased production requirements. This is often a surprise to the foreign buyer, who had been assured by the manufacturer that it has ample capacity for any scale of orders.
- The stress of increased production demand causes the quality level from the Chinese manufacturer to progressively decline, reaching unacceptable levels. This is often a surprise to the foreign buyer, who had expected quality to improve over time.
In response to these issues, the foreign buyer gives notice to its Chinese manufacturer that it intends to move production to a different manufacturer, often a direct competitor of the current manufacturer. In the past, the issues that arose at this stage mostly focused on ownership of the physical molds. This issue can be resolved by a relatively simple mold ownership agreement. To the extent that a mold ownership agreement resolves the issues, this is old news.
However, in the past year we have seen Chinese factories make arguments (like those below) that render the situation far more complex:
- The Chinese factory says: “It is true you paid the fabrication fee for the molds. But that fee only covered the material costs and the time involved. However, in addition to that, we at the factory spent a lot of time and money doing the CAD drawings and related specifications required to fabricate the molds and we also spent additional engineering time in integrating the molds into our production process. Before you can take the molds, you have to compensate us for those costs. We won’t even charge you a markup. Just pay us for our out of pocket costs.” Then the factory provides an unreasonably high invoice for those costs and if you do not pay the invoice, the factory will continue to hold your molds hostage. This has become almost standard practice in outsource manufacturing, particularly in southern China. It is therefore essential for foreign designers to make clear in a written contract that all amounts paid for molds include both design and fabrication costs and that no additional payments will be required when the foreign buyer seeks to take possession of the molds.
- The Chinese factory says: “It is true that you own the molds and you can take them whenever you want. However, we did all the design work on those molds so we own the design embodied by the molds. We will give you a license to use the molds in production in another factory. However, that license is limited. You have no right to copy the molds. We, on the other hand, have the right to copy the molds and we have the right to use the mold design for our own production or to provide copies of the molds to third party factories for their own production. The only thing you own is the physical object. You do not own anything else.”
- In the more extreme case, the Chinese factory says: “We did all the design work for the molds so we own that design and we already registered a design patent in the molds. Since we did all the work, we are the inventor for patent purposes. It does not matter that you paid us for the molds. We still remain the inventor and our design patent protects us. You can have the physical molds, but if you want to use those molds for production at a different factory, you must pay us a royalty fee.” This royalty is then quoted at a price so hight that you cannot economically have your product produced at a third party facility.\
- Lately, the more honest Chinese factories make the situation clear. The foreign buyer pays for fabricating the mold, but that payment does not convey any ownership interest in the molds to the foreign buyer. The Chinese factory does the design work and the Chinese factory owns the molds. The Chinese factory will agree to use the molds only for the purpose of producing the product for the foreign buyer, however, the foreign buyer has no right to move the molds to any other factory. In this setting, some Chinese factories will say that you are free to make new molds at your new factory, but some will assert ownership to the mold design and not allow you to have copies made at the new factory. Often Chinese factories will make this contention even when they do not have a registered design patent. To them the situation is obvious. They both designed the mold and arranged for its fabrication and so they own all rights in the mold without any need to register a design patent. Whether this position would be supported by a court is unclear. But since it is unclear, most Chinese factories will refuse to work with the new factory. What is so interesting about this approach is that the Chinese factory is clear about its intent from the beginning. The Chinese factory intends to hold the foreign buyer hostage by guaranteeing that the foreign buyer cannot go to any other factory in China as an alternative manufacturer of the product. By holding the foreign buyer hostage, when the Chinese factory raises its price or delivers the products late or produces defective products, the foreign party is pretty much trapped. It has no place else to go and no real leverage for dealing with the issues. We are getting a call a week from foreign companies in these situations, with little that can be done beyond essentially starting over.
This is where outsource manufacturing is going in China. Foreign product designers need to deal with it. At a first level, the foreign designer can enter into written contracts that provide protection. However, at a second level, if the Chinese factory intends the “hostage” result, it will reject signing a contract that will prevent that. When that happens the foreign designer is forced to face reality and decide whether manufacturing its new and innovative product in a setting where it is hostage to a Chinese factory makes economic sense or not. Or whether it can or should try to find another manufacturer. Our clients often argue that it does make sense. We are not so sure.