Legal News

The Five Keys for Reducing Your China Manufacturing Risks

Five Keys to a International Trade Secret Protection

In response to yesterday’s post containing outsourcing tips from a business perspective a reader sent me an e-mail asking what to look out for on the legal side. Fortunately, I was able to find a short article fellow blogger Steve Dickinson had published a few years ago on just this topic and here it is:

Many small and medium sized companies that engage in OEM manufacturing/outsourcing in China fail to take the 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. The fact is that most outsourcing disputes must be resolved in China, under the Chinese legal system. The Chinese legal system 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 protections 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.

  • Create and properly register your intellectual property rights in the United States or your home country. If you do not have a firm basis for your IP rights under US law or that of your home country, you likely will have nothing to protect in China. Before you go to China, be sure your intellectual property is protected under the laws of your home country. Protect your brand identity by creating and registering your trademark, slogan and logo with the relevant Patent and Trademark Offices. Register your important copyrights with the relevant Copyright Office. Carefully identify and protect your trade secrets, proprietary information and know how.  All of this will help prevent Chinese copies from entering the United States or your home country.
  • 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.
  • Use a written agreement to protect your know-how and trade secrets in China. Small and medium sized companies usually do not have an extensive portfolio of patents. Their most valuable intangible assets typically are their know-how and 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 also address issues such as non-competition and confidentiality. Without such a written agreement, virtually no such protection is available.
  • 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 provide for a clear procedure for dealing with these problems as they arise. You must take the lead on this. You cannot depend on your OEM manufacturer to do this for you.
  • Use comprehensive OEM Manufacturing Agreements with each manufacturer. Small and medium sized businesses often enter into OEM manufacturing transactions with a simple purchase order. This is a mistake. The purchase order will protect the Chinese manufacturer, not you. Your protection depends on your securing a written OEM manufacturing contract with each of your Chinese manufacturers. The ideal manufacturing agreement will address all of the issues discussed above while also addressing other basic legal issues such as jurisdiction and dispute resolution. This agreement should be in both Chinese and English, since the Chinese language version will control in China. It should be clear that Chinese is the official language of the contract.

Above all else, remember that if you are outsourcing to China you are in effect doing business in China and you need to adjust accordingly.

All of this was true a couple years ago and all of this is true today.

What are you seeing out there?

7 responses to “The Five Keys for Reducing Your China Manufacturing Risks”

  1. There’s a 6th one: set up your business in Hong Kong and be ruled under English law instead of Chinese one. Moreover companies can get all the tax advantages that being placed there suppose (Off Shore Company).

  2. Miki —
    Thanks for checking in.
    I completely disagree. I view HK as great for the big companies, but too expensive for the small. If you want to be ruled by English law, put that in your contract. However, as one who arbitrated a case before three British arbitrators, all of whom were charging 600 pounds and up per hour, I am not that big a fan. I greatly respect British law and British lawyers (hell, some of my best friends are British lawyers), but their fees put we American lawyers to shame.
    I have actually had a post in the pipeline for months now, tentatively entitled, “Hong Kong, What Hong Kong.”

  3. An excellent post as usual. I would remark, however, that any legal remedy provides shallow comfort once a company’s IP has left the building. That thought leads me to what I consider the fundamental Rule Number 1 which proceeds all other rules — take the time and make the effort to choose your partners carefully in the first place. I know this is a sentiment you’ve discussed in previous posts. Not all business people in developing markets are corrupt and it is possible through some basic homework to discern the better partners from the poor ones.

  4. Craig —
    Thanks for checking in. I completely agree with you. Protecting one’s IP through non-legal means is at least as important as through the law and knowing with whom you are dealing is point #1.

  5. China QC Because It Matters
    The All Roads Lead to China blog just did a very helpful post, on quality control (QC) when outsourcing, entitled, QC Failures Start in the Home. All Roads starts out by referring to our post on Outsourcing in China: Five

  6. Get On The China Train, Hard Seat Notwithstanding
    Had a long conversation today with a longtime client on the pros and cons of doing business in China. His is relatively small, but very international company that is being pushed hard on prices by competitors that are much farther

  7. Get On The China Train, Hard Seat Notwithstanding
    Had a long conversation today with a longtime client on the pros and cons of doing business in China.  His is relatively small, but very international company that is being pushed hard on prices by competitors that are much farther along in China …

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