Who Owns "Your" Overseas Factory and Why it Really Matters

At least once a month someone will tell us they do not need a China-centric contract with their China-based manufacturer because their China-based manufacturer is owned by an American or a European company. To which I always say, “no it isn’t.”

Here’s the deal. No American or European or Australian company (or any other non-Chinese company) can own a Chinese factory directly. It is possible the American or European or Australian company that claims to own a Chinese factory owns a Chinese company (a WFOE or a China Joint Venture) that in turns owns a Chinese factory, but the odds of this are incredibly slim. None of my law firm’s international manufacturing lawyers have ever encountered a foreign company that owns a Chinese company that owns a Chinese factory that does contract manufacturing for third party companies. Something like this is possible, but it is exceedingly rare simply because third party manufacturing is nearly always a complicated, localized and low margin business.

So what does it mean when a foreign company claims to own the Chinese factory from which it is trying to get you to place your orders? This pretty much can mean one of the following two things:

1. The foreign company that claims to own a Chinese factory is flat out lying. It is amazing how often we see this and when I say “see this” I mean the foreign company puts in writing “that your products will be made by factories we own in China.” If you see this, you probably should run away. Fast.

2. The foreign company is fudging the truth. A lot. This occurs when the foreign company speaks of having your products made by “our factories” in China. If you push them on what they mean by “our factories,” they will usually state that the factories in China to which they are referring are the factories they have worked with for many years and know well and trust. Do they own these factories? No, they just work with them and you too could just work with them.

Does any of this matter? As someone whose law firm has been involved in many lawsuits on this issue, let me tell you it matters a lot. It matters because companies that believe they are buying their widgets from an American or European or Australian company (hereafter referred to as the “AEA Company”) are (1) generally willing to pay more for the “safety” that comes from doing business with an AEA company, (2) generally willing to be relaxed about the contract they sign with the AEA company, and (3) relaxed about protecting their IP from China because they believe they are inherently protected because AEA law applies and there is no China company from which IP (or any other) protection is needed.

Unfortunately, the widget buyer could not be more wrong. The widget buyer now has a contract with an AEA company that has no legal connection with the Chinese manufacturer. The widget buyer also very likely has no contract with its Chinese manufacturer mandating that the Chinese manufacturer deliver quality widgets on time and at a certain price. It also virtually never has a contract with its Chinese manufacturer that prohibits the Chinese manufacturer from stealing your IP and no contract with the Chinese manufacturer that prohibits the Chinese manufacturer from selling your product to your customers.

We have seen unbelievably large disasters that have stemmed from these sorts of situations, including instances where the foreign product buying company has literally gone bankrupt after having been scammed and then stolen from, all without any good recourse. We have sued AEA companies that have engaged in such tactics, but because companies that engage in such lying/fudging are not exactly stand-up companies flush with cash, bringing a lawsuit will be a waste of time. The key is to prevent your company from getting caught up in such a situation in the first place.

Our international manufacturing lawyers have been seeing an increase in AEA companies claiming to “have factories” in China and we think that is because COVID has made it more difficult for companies to scope out Chinese factories themselves and then buy direct.

If you enter into this sort of tripartite relationship you will almost invariably have problems that are difficult or impossible to solve. I will in my next post talk about the sorts of problems we frequently see in these situations.

Almost invariably, if you give this sort of tripartite relationship 6-12 months, you will have problems that are extremely difficult or even impossible to solve.

In China Sourcing: Does Your Sales Contact Really Work At The Factory? Renaud Anjoran wrote of the importance of making sure you know who actually owns the factory in which you will be having your products made. In his post, Renaud focused on another very common type of situation where the foreign buyer ends up not knowing who the owner of its manufacturer actually is and ends up dealing with a non-owner. Per Renaud (and also what our China manufacturing lawyers have so often seen), the following is common:

1. The purchaser researches Alibaba and has about an 80% chance of ending up with a trading company.

2. The sales contact person keeps saying he/she works “at the factory”, but they don’t.

3. The supplier’s company name (which will receive the payment) is that of the trading company. It usually doesn’t include the words “Trading” or “Import & Export”. (They still do NOT look like a manufacturer’s company name, but foreign buyers seldom know that.) Alternatively, that company is in Hong Kong or Taiwan and is presented as “the factory’s sales office, for greater convenience”.

4. The purchaser does not research and is misled all along.

5. The situation often becomes clear when things have gone wrong… and the whole supply chain needs to be re-built.

With so many foreign companies moving their manufacturing from China to places like Taiwan, Thailand, Vietnam, Malaysia, Pakistan, and Mexico, among other places, we are seeing this same sort of deception again, but with a new twist. This time around, about 80 percent of the time it is a Chinese company claiming to own the factory in some foreign country (including all of the countries mentioned above) and it often also insists that its contract with you to make widgets is sufficient and applicable to the new country as well. But we are finding — without any exceptions so far — that the Chinese company with which our client had a contract for manufacturing in China does not directly own the factory in the country in which it claims to be doing its manufacturing. In other words, your existing contract with your Chinese manufacturer is likely to be worthless (or nearly worthless) at protecting your company when manufacturing in that third country.

If you are going to have your products made in Thailand or Vietnam, it will almost always (but not always) make sense for you to have your contract with the company that will be making your products in Thailand or Vietnam and to have that contract written for Thailand or Vietnam under Thai or Vietnamese law. The same holds true for Taiwan, Malaysia, Indonesia, Mexico or wherever. If your contracts are not with the actual owner of the factory in which your products will be made and tailored to the country in which the manufacturing is taking place, you are asking for trouble. See e.g., Manufacturing Contracts When Manufacturing in Multiple Countries.

For more on what to be looking out for when moving your manufacturing from China, check out the following:

- Moving Supply Chains From China to Southeast Asia/South Asia: The Three Big Issues

I apologize for just “dumping” so many articles on you, but I have done so because our international manufacturing lawyers are constantly getting asked “what should I be reading on moving our manufacturing out of China” and I just really wanted to get these various articles in one place.