China’s recently stepped up efforts to root out unregistered foreign businesses in China has caused a rash of China consultants to retain the China lawyers at my law firm.
From our work in forming China WFOEs (wholly foreign owned entities) for these consultants, we have discovered that many China consultants are falling dangerously short in various other legal aspects of their business as well. Indeed, if we were to single out the foreign businesses in China most often guilty of underestimating their legal risks, it would be China consultants, so many of whom have been in China so long they seem to have forgotten that when push comes to shove, they are the people called to answer for what happened. These China hands also do not seem to realize how much China has changed and that doing business in China today is not the same as it was five years ago.
If you are a Western consultant hired by a Western company to assist in China, you need to realize that if something goes wrong for your client you will be your client’s first choice for legal redress. You will be who gets sued.
We have seen the biggest problems with sourcing consultants that assist in finding Chinese manufacturers. A typical sourcing project might go like this:
- A Western company retains a product sourcing consultant to find “the best” Chinese widget manufacturer for cost, quality and/or dependability.
- The product sourcing consultant secures a sample widget from the Western company.
- The product sourcing consultant meets with countless Chinese manufacturers in search of the best one.
- The product sourcing consultant recommends Chinese manufacturing company Z manufacture 100 million widgets.
- The product sourcing consultant is paid a percentage of the manufacturing costs.
- Chinese Company Z starts manufacturing the widgets.
By this point, I am guessing the sourcing consultants out there are saying, “yes,” while the China attorneys out there are apoplectic. Let’s deconstruct the above hypothetical project and note where the consultant might harm its client and needlessly take on huge liabilities.
1. The sourcing consultant agreed to find the “best” widget manufacturer. Is that the best in China or the the world? What if the widget manufacturer charges one hundred dollars a widget for the 100 million widgets, but your client’s competitor finds another widget manufacturer that makes equivalent quality widgets for ninety dollars each. Are you liable for the cost difference? Even worse, what if your client’s competitor gets the same Chinese widget manufacturer to do its 100 million widgets for ten dollars less? Do you really think a US jury is going to believe that you were doing your best when your fee was a percentage of the final costs? Are you responsible for the Chinese manufacturer’s late deliveries? For the Chinese manufacturer’s bad product? Is it clear exactly on what your percentage is going to be based and have you set things up so that your client cannot just go around you? The Solution: Make clear by way of a well-crafted written contract between you and your client exactly what you are doing and not doing. Put in a non-circumvention provision to make sure your client cannot go around you.
2. If you take a sample to China and start showing it to potential manufacturers without FIRST having put in place various IP safeguards, you are courting disaster. Your client’s sample could be used for counterfeiting and the trademark on the sample (or your client’s name) could also be stolen. On many occasions we have had sourcing consultants call one of our China lawyers after having learned that one of the Chinese manufacturers to which it had shown a sample was now manufacturing the product for someone else using the client’s trademark. The Solution: Never show a sample or product plan to anyone in China (or anywhere else for that matter) without first making the manufacturer sign an NNN Agreement (non-compete, non-circumvent, non-disclosure). You also should not reveal any brand name or trademark information at this point. Better yet, make sure your client has registered its brand name as a trademark in China BEFORE you hit the ground in China. The same holds true if patent or copyright protection is necessary.
3. If you as the consultant will just be negotiating the price and delivery dates, you should make very clear in writing that these are your only tasks. Typically, product sourcing consultants oversee the OEM contract with the manufacturer and by doing so, they are exposing themselves to liability issues if that contract is not up to snuff. You are the “China expert” and your client is counting on you to guide it through China’s minefields. You are the one who is supposed to know anything and everything about what it takes to do business in China and nine times out of ten, you sold yourself to your client as a China expert and that is exactly how your client views you. Your client probably thinks its existing patents, trademarks and copyrights will protect it in China, but a court will expect you as the China expert to know better. The Solution. Put in writing with your client that you will not be providing legal advice and it should retain its own China lawyer to draft the manufacturing agreement with its Chinese manufacturer and to register its IP in China.
Just remember that your client sees you as the expert at doing business in China and it is looking to you for help, and if you fall short in any way, you are at risk for a lawsuit.
So China consultant, protect yourself.
