Would the Last Company Manufacturing in China Please Turn Off the Lights, Part 5

International Location Lawyers

Five years ago, for every 100 companies our China lawyers helped set up contract manufacturing in China, we helped maybe one end its contract manufacturing in China. Two years ago, that ratio was maybe 100 going to China and five leaving. Today, for every company our law firm helps set up manufacturing in China we help around the same number leave or at least try to leave. And because far fewer companies realize the need for legal counsel when ceasing to manufacture in China (as opposed to starting to manufacture in China), I have concluded that far more companies are ceasing to manufacture in China than are starting to manufacture in China.

This post addresses how best to extricate from your Chinese factory.

My law firm’s advice every single time to our clients who are laying off workers in China or closing a facility in China or allegedly owing money in China is to stay outside China  for any all negotiations. The same holds true for ceasing to manufacture in China. The below is our advice if you are in a dispute with a Chinese company or if you might owe money to a Chinese company. One only needs to be a regular reader of our blog to know that we took this position long ago and have never waffled:

  • The best thing to do is not go to China at all.
  • If you must go to China, think about using a bodyguard or two or three and think very carefully about where you stay and where you go. Most importantly, be very careful with whom you meet.
  • Consider preemptively suing the alleged creditor somewhere so that you can very plausibly claim that you have been seized not because you owe a debt but out of retaliation for having sued someone. If you are going to sue, carry proof of your lawsuit with you at all times while you are in China.

In a similar vein, we have also written extensively on the importance of preparing well in advance for terminating your China supplier. And by plan in advance, we mean make sure that you have secured your molds and all paid-for product before you do anything that might tip off your China supplier regarding your plan to start manufacturing elsewhere. It typically makes sense to have a new supplier lined up or at least in mind for when you make your exit. Last week, I worked on manufacturing exit plans for two companies, and both have a six month time frame, which is about average as they usually range from three to nine months.

For obvious reasons, few companies that have major problems trying to leave their China supplier speak about it to the press, but many years ago, in Jilted Chinese supplier tells would-be U.S. reshorer -“Not so fast,” an American toy company did, largely because it brought a lawsuit in the United States against its Chinese supplier. The article describes the lawsuit as based largely on allegations that the Chinese supplier ceased providing the American company credit and delayed deliveries, all in an attempt to make it impossible for the American company to start making its toys in the United States.

Though I have no idea whether the allegations in this lawsuit are true, I do know it is common for Chinese manufacturers to seek retaliation against their American product buyers that cease buying product from them. For this reason, we instruct our clients to line up new suppliers and have them ready to go before they even hint that they might cease production with their existing China suppliers. We give this advice because over the years our China lawyers have repeatedly seen the following:

  • Foreign company tells its China manufacturer it will no longer use its China manufacturer for its production. China manufacturer then keeps all of the foreign company’s tooling and molds, claiming to own them. The way to prevent this is to get an agreement from your Chinese manufacturer that you own the tooling and molds before your Chinese manufacturer has any inkling you will be moving on. For more on the importance of mold agreements, check out How Not To Lose Your Molds In China and Want Your China-Based Molds? You’re Probably Too Late For That.
  • U.S. company tells its China manufacturer that it will be ceasing to use China manufacturer for its production. The China manufacturer then registers the U.S. company’s brand names and logos as trademarks in China and a key element of its product as utility patents in China and in the United States and then starts selling the U.S. company’s products around the world, using the U.S. company’s brand names. The U.S. company sues the Chinese company for patent infringement in China and for infringement of its U.S. trademarks in Seattle. The Chinese company then sues the U.S. company twice in Texas for patent infringement. The three U.S. cases are eventually consolidated (by agreement) in San Francisco and the U.S. company loses its patent challenge in China. I mention all this to tell you the high costs companies often have to pay for leaving their manufacturer without advance planning.
  • Foreign  company tells its China manufacturer that it will be ceasing to use China manufacturer for its production. A few weeks later, foreign company has its products seized at the China border for violating someone’s trademark or design patent. The foreign company is (rightly) convinced that its China manufacturer is the one behind the product seizure, believing the Chinese manufacturer registered the foreign company’s brand names as trademarks in China long ago and is just now using that trademark to seize its product as revenge (or just registered the design patent). China has laws forbidding its manufacturers from registering the trademarks of those for whom it manufactures, but because it is usually not possible to prove it is your Shenzhen’s cousin in Xi’an that did the trademark registration, this sort of thing goes on unchecked. For how to prevent this from happening to you, check out the following:
  • Foreign company tells its China manufacturer that it will no longer use it for its production. China manufacturer then says that it will not be shipping any more product because the foreign manufacturer is late on payment and owes it hundreds of thousands of dollars. China manufacturer then reports the foreign manufacturer to Sinosure and Sinosure then ceases to insure product sales to this foreign company, which convinces all of the foreign company’s other Chinese manufacturers not to sell anything to the foreign company without 100% payment upfront. We see this particular scenario all the time and for more on how these Sinosure cases go down, check out China’s Sinosure: It’s Back and It Wants Your First Born. Sinosure is relentless and I’ve seen it drive good companies into bankruptcy.
  • US company tells its China manufacturer that it will be ceasing to use China manufacturer for its production. China manufacturer then either threatens to or actually does hold people from the US company hostage for alleged debt. For more on the problems that can arise from allegations of not having paid a debt to a Chinese company, check out China Hostage Situation. Now IS A Good Time To Pay Your Debts and How Not To Get Kidnapped In China, Part 3. Resolve Your Debt Problems Before You Go.

You should always plan ahead for pulling your production from your Chinese manufacturer. This planning ahead usually involves the following:

1. Not telling your Chinese manufacturer you are even contemplating leaving it until you are completely prepared to leave.
2. Making sure you have good contracts with your Chinese manufacturer before you leave it. If you don’t have good contracts with your manufacturer now, get them. These contracts will make it much tougher for your manufacturer to sabotage you when you leave.
3. Make sure your IP protections are in order before you leave your Chinese manufacturer.
4. Make sure your alternative supplier(s) are truly lined up and ready to go before you leave. We have had clients who left their Chinese manufacturer for a new manufacturer in another country and then had to wait 6 months to get good product from their new manufacturer. I realize there is cost savings by not duplicating production, but there are also big risks.
5. Figure out exactly what your total costs will be before moving your manufacturing to a new manufacturer in a new country. We have had companies come to our law firm after their move seeking help with re-negotiating their arrangements with their new manufacturer because they didn’t realize that the shipping costs would be higher or that their widgets would be a subject to a tariff or that they were expected to pay xyz tax or whatever. Just realize that these sorts of “extra” costs can vary tremendously country by country, as can the expectation as to who is responsible for paying them.

What are you seeing out there?