Worthless China Contracts: First, Let’s Sue All the Lawyers

China Lawyers

No more Mr. Nice Guy.

In the last year or so, China has rapidly stepped up its technology game. Its larger, better known companies (and many of its smaller and lesser known companies as well) are rapidly seeking to up their technology game. To put it bluntly, their first goal is to get high end technology from American and European and Australian (mostly) companies for free. Failing that, it is to get that technology as cheaply as possible. We have written about this many times, most recently in China Technology Licensing Versus China Joint Ventures: Same Same and How to Avoid Inadvertently Gifting your IP to your Foreign Manufacturer.

Okay, so what does all this have to do with the title of this post? Let me explain.

In the last few months alone, our China lawyers have been confronted with what feels like an endless stream of instances where foreign lawyers have essentially committed malpractice to the extreme detriment of their clients. I wrote about this (with much less of an emphasis on the lawyers who allowed it to happen, just a few weeks ago, in China and The Internet of Things and How to Destroy Your Own Company:

In describing IoT companies and their problems to others, I use the following as my prime example, taken from at least a half dozen real life examples in just the last few months:

IoT Company: We just completed our Kickstarter campaign and we totally killed it and so now we are ready to get serious about protecting our IP in China.

One of our China Lawyers: Great. Where are you right now with China?

IoT Company: We have been working with a great company in Shenzhen. Together we are working on wrapping up the product and it should be ready in a few months.

China Lawyer: Okay. Do you have any sort of agreement yet with this Chinese company regarding your IP or even costs or anything else.

IoT Company: No. All we have is an MOU (Memorandum of Understanding). They’ve really been great. They have told us that they would enter into a contract with us whenever we are ready.

China Lawyer: Can you please send us the MOU?

IoT Company: Sure.

China Lawyer: Okay, we will look at that and then get back to you with our thoughts.

Then, a day or two later we had a conversation like the following ensues:

China Lawyer: We looked at your “MOU” and we have bad news for you. We think there is a very good chance a Chinese court would view that MOU as a contract. (For why we say this, check out China LOI and MOU: Don’t Let Them Happen to You.) And the Chinese language portion of the MOU — which is all a Chinese court will be considering — is quite different than the English language portion. The Chinese language portion says any IP the two of you develop (the IoT company and the Chinese manufacturer) belongs to the Chinese company. So what we see is that as things now stand, there is a very good chance the Chinese company owns your IP. This being the case, there is no point in our writing a Product Development Agreement your Chinese manufacturer is not going to sign.

IoT Company: (And I swear we get this sort of response at least 90 percent of the time) I’m not worried. I think you have it wrong. I’m sure they will sign such an agreement because we orally agreed on this before we even started the project.

China Lawyer: That’s fine, but I still think it makes sense for you to at least make sure they will sign a new contract making clear all the IP associated with your product belongs to you, because if they won’t, there is no point in our drafting such a contract and, most importantly, there is no point in your paying us to do so.

So far not a single such IoT company has been able to come back to us with an agreement from their Chinese manufacturer to sign.

In that same post, I wrote of the following variation on the same theme:

We have lately been getting a slight variation on this theme, where the IoT company is farther along in its product development and is actually now at the point of selling its product. This newer situation is exemplified by the email below, which is an amalgamation of various recent emails, with any and all kinds of modifiers to make it impossible for anyone to be able to guess the companies:

Here is my situation. I am hoping your firm can help us figure out the best course of action going forward. [Then usually follows a description of their company and their IoT product and how they ended up going with a particular Chinese manufacturer and why they failed to seek out the advice of a China lawyer until now. BTW, this description far too often involves their domestic attorney having told them he or she would turn them over to a “China specialist” as soon as that “becomes necessary.”]

We do not have any contracts in place with our current manufacturer. We started the relationship with our current manufacturer a year ago. He told us POs are contracts in China and our lawyer here confirmed that. We sent him our design, paid for the molds, and he shipped us the products. Recently, we learned he used our product pictures as marketing material on Alibaba and we suspect he is selling our products all over the world. A week or so later, I found out he has filed for a design patent for our design in China.

We just started the working relationship with [online retailer]. Our manufacturer doesn’t know that. All I told him is that we are working with a big client, and if he doesn’t sign any agreements with us at this point, we’re not going to place new orders. He then told me he’s willing to sign a non-disclosure agreement with us. But based on what he has done, I don’t think it is in his best interest to work with us in the long run.

We’re filing design patents in the US. If we continue to work with him during this period, which agreement would help us get the best protection?

Since he already claimed our designs in China, will that prevent us from working with a new manufacturer?

Do you advise we work with a new manufacturer at this point?

Our response has been something like the following:

A PO is not really a contract; it is the placing of one order. Unless your PO speaks to IP (which would be unusual), it almost certainly will not help you here. On top of this, some Chinese courts do not see POs as a contract at all and some Chinese courts will not even look at a document not in Chinese. The ideal is a Chinese language contract sealed by the Chinese company.

Our biggest concern is that this manufacturer has gone off and filed for a design patent for your product. This will no doubt pose problems for you and for any new Chinese manufacturer you might seek to use. Depending on how far along your present manufacturer is in the patent process, it may be able to sue you and your Chinese manufacturer for damages and to force production to cease. At minimum, it will be able to cause you all sorts of problems unless you can stop or invalidate its design patent. At this point, there is a good chance this Chinese manufacturer literally owns your product in China and can use that ownership to control what you do there.

If you seek to go to a new manufacturer you can be sure of two things: one, your old manufacturer will NOT give you the molds you think you paid for and two, it will use its design patent to, at minimum, block your products from leaving China. It also very well may sue you for patent infringement in a Chinese court. In the meantime, making your product in China will be an extremely high risk proposition.

Based on the information you have provided us, it appears you have the following four options, none of which are terribly good:

1. You leave China entirely and you start manufacturing in some other country. Is this possible?

2. You seek to block or invalidate your manufacturer’s design patent. This will not be accomplished quickly or inexpensively.

3. You try to strike some sort of deal with your manufacturer whereby it assigns the patents to you and in return you agree to keep using it for manufacturing for x number of years. It may agree to this if what you can pay it will exceed what it can make by selling your product on its own. The fact that it has offered to sign a non disclosure agreement does not mean much at all, since such an agreement will not help you and your manufacturer almost certainly knows this. For why this is the case, check out Why Your NDA Does Not Work for China. You need it to sign a contract that actually makes clear what IP belongs to you and makes clear his limitations in using your IP. At this point, it sounds like you need a China-centric manufacturing agreement that makes clear who owns what.

4. You go to a new manufacturer in China. If you do this, you almost certainly will not have your molds and there is a good chance your existing manufacturer will make a lot of trouble for you by suing or threatening the new manufacturer, etc.

Don’t let the above happen to you. For more on how you can prevent this, go read China NNN Agreements and China Product Development Agreements.

Now for the “suing all the lawyers” part. In most of these instances where the tech company has pretty much just relinquished its most valuable asset (the IP it took years to develop) to a Chinese company, the tech company was represented by a domestic lawyer. And in most of those instances — or so we have been told — the domestic lawyer told its tech client it would be able to save it money by using them for “the basic agreements” and then using a “more specialized China lawyer” when necessary. But as you can see from the above, the domestic lawyers too often guess badly wrong on the “necessary” part of this equation. In fact, most of the time, it is the tech company, not its lawyer, who finally makes the decision to call the China lawyers at my law firm and that usually happens when the tech company starts sensing something is going wrong with its China situation.

So it is with some amount of regret that I am now going to start adding a fifth option to the four I list above:

5. Consult with your local malpractice lawyer about suing your lawyer who led you to believe he or she was qualified to assist you in dealing with China and then allowed you to get into the really bad situation in which you now find yourself.

#Sorry

One response to “Worthless China Contracts: First, Let’s Sue All the Lawyers”

  1. Dan: CONGRATULATIONS on such a post!
    Honestly I think that you might as well remove the adjective “American” before “lawyers”. At least for what I am observing around since a fair amount of time, I think that this is not just a problem related to the US, it is not showing up only recently and not only with regard to IT. This kind of ‘suicidal’ approach is put in place quite often – way too often: lawyers who have no idea about China and about how things work here pretend to be ‘China law experts’. At the end of the day, the only things they bring about are enormous damages to companies in their countries (which in particular in the case of SMEs, are in general quite painful – i.e. companies blown up after they lose their tech advantages in favor of their once ‘friends’ and then fierce competitors from China etc.).
    It is quite an annoying and unfair competition from our colleagues! Just a few days ago, I was actually wondering whether to arrange a talk with the high floors of the Bar Association in my country, but then I dropped the idea because I saw it quite unrealistic or at least enormously difficult for the Bar Association itself to take any effective measure to prevent this kind of behavior.
    Nonetheless, I think that stimulating clients to sue these lawyers for malpractice as you suggested could be among the most effective remedies + I do believe that posts like this may also provide a valuable contribution in reducing the impact of SUCH A LOSE-LOSE GAME by lots of our colleagues.
    Again Congratulations on the post and thanks for giving visibility to this topic!

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