NDAs Do NOT Work for China but NNN Agreements Do

You Need an NNN Agreement for China IP Protection

Relying on a standard Western-style NDA to protect your IP from China sets you up for IP theft because NDAs have critical limitations that render them ineffective for China. You need an NNN agreement tailored specifically for China.

This post explains what an NNN agreement is, why it’s superior to NDAs for China, and how to craft one that will protect your IP.

China IP Theft is Soaring

Many Chinese factories are struggling. One method they use to juice their profits is to steal and then sell other people’s products. My law firm’s China IP lawyers have been seeing a massive increase in China IP thefts. See China Trademark Theft. It’s Baaaaaack in a Big Way.

Chinese factories perceive foreign firms, especially those from the US, Canada, and Europe, as wanting to move their manufacturing from China. This makes them skeptical about long-term relationships with their foreign counterparts. It may not make sense to steal IP from a company that will provide you with ten years of steady profits, but it sure is tempting to steal IP from a company that will likely soon be severing all ties. See Your China Factory as Your Toughest Competitor.

China IP Theft in Real Life

The below is atypical email from a company whose IP was stolen by its Chinese factory:

I’ve run into a bit of a problem. I was told you could help. Here’s what happened:

Back in April, I decided to make a product to sell on Amazon. I got a sample from a Chinese manufacturer but wanted to make some tweaks. I figured one of those changes might be worth a patent, so I got a US lawyer and I now have a patent pending.

Once I got that going, I had the manufacturer sign the attached NDA. I gave them my design, expecting a mold by August. They kept delaying. Yesterday, they showed me a new product of theirs. It’s got all my changes – the only difference is the color!

They say they started on this back in March and that they are shipping it out next week. How’s that right when they signed my NDA and I’ve got a patent? Can you look into this? How much would that cost?

The below is the substantive portion of the response from one of our China IP lawyers:

China NDA, NNN, and IP Takeaways

Your takeaways from the above should be as follows:

1. Do not rely on a Western contract to protect your IP from a Chinese company.
2. NDAs do not work for protecting IP from China. China-Specific NNN Agreements are what you need. See China-Specific NNN Agreements Versus a Template Non-Disclosure Agreement (NDA).
3. Patents are sometimes great, but often cost considerably more than better ways to protect your IP from China.
4. You need to protect your molds by contract as well. See Protecting Your Molds and Tooling When Manufacturing Overseas.

Non-Disclosure Agreements (NDAs) Do Not Work for China

Because China’s legal system diverges significantly from those in the United States, the EU, Australia, Canada, and Latin America, one should never presume Western legal practices work for China. Western-style NDA Agreements do not work for China and well over 90 percent of the NDAs that our China lawyers are actually worse for China than having no agreement at all. See Why Your NDA is WORSE Than Nothing for China.

NDAs fail on four fundamental levels in China:

First, Chinese companies are usually not interested in publicly disclosing your ideas. Their goal is to use your ideas for personal gain. You need an agreement that does more than just prohibit disclosure.

Second, most NDAs discuss protecting trade secrets, but Chinese manufacturers are quite capable of duplicating products without using any trade secrets.

Third, most NDAs call for jurisdiction/enforcement in the product buyer’s country, rather than in China, even though it usually makes sense to have your IP protection agreements be in Chinese, governed by Chinese law, and enforceable in Chinese courts. See Drafting China Contracts that Work.

Fourth, and most importantly, most NDA Agreements will not be enforced in China.

The three “Ns” that make up China NNN agreements are: non-use, non-disclosure, and non-circumvention. Let’s look at each of these in turn.

a. Non-Use

Non-use means your China counterparty agrees not to use your concept or product other than for you. It’s not about trademark, copyright, patent, or trade secret classifications. It’s purely contractual. If the Chinese company breaches your non-use provision, it’s breaking the agreement. It’s critical that you and your Chinese factory agree on what your Chinese factory cannot use. If you say that it cannot use your product, it will believe it can modify your product and use that. You need to get specific while also remaining general, and you need to do so in a way Chinese courts understand.

b. Non-Disclosure

Non-disclosure is another crucial component of a China NNN Agreement. Chinese companies are usually not interested in publicly disclosing your ideas. Their goal is to use your ideas for personal gain. But if you don’t craft your NNN appropriately, your Chinese manufacturer might have various giant loopholes to do exactly that.

Your NNN Agreement should be written to protect you against the following common situations in China:

• Families might own multiple small to medium companies, that they view as one entity.
• Chinese manufacturers invariably rely on subcontractors to provide them with product components. These subcontractors are typically linked to the manufacturer by family, co-ownership, roles, or location, and the manufacturer usually provides these companies with your information for cost estimation (early on) or for production (later on).
• Large Chinese “group company” setups involve numerous subsidiaries under one parent company. They typically don’t view disclosure within this group as an issue.
• State-owned enterprises (SOEs) commonly consider other SOEs as part of the same entity — the Chinese government. This causes them to frequently share foreign company information with other SOEs.

If you prohibit a Chinese company from using your protected information, the clever Chinese company will not directly breach the non-use prohibition. It will instead disclose the protected information to someone in its “group” and then deny having breached the non-use prohibition because it did not directly use the protected information.

It is critical you understand the type of group with which you are dealing, and in your NNN Agreement make clear that disclosure is specifically prohibited within the group. Most importantly, your NNN Agreement needs to be clear that if there is any infringement by any member of the group, the company that signed your agreement and made the disclosure will be fully liable, no matter what. If drafted correctly, Chinese courts generally enforce such provisions. More importantly, Chinese companies believe that Chinese courts enforce such provisions, and this makes them reluctant to breach them.

c. Non-Circumvention

The final “N” is non-circumvention. Here’s an example to illustrate its importance: if you purchase a product from your Chinese factory and sell it at a marked-up price abroad, what happens if the factory sells directly to your customers at a significantly reduced price? Depending on the industry, some of your customers might remain loyal, but others might not.

A robust non-circumvention clause in your contract is your best safeguard against such practices. If you merely block your Chinese factory from making your product, you leave it open to making a similar product and then reaching out to your customers and telling them that they are your factory and they will now sell them a similar product for half of what you are charging them.

Contract damages provisions in a China NNN contract provide three main benefits. First, they force the Chinese party to realize it will face real and quantifiable consequences if it breaches the NNN agreement. Second, a specific monetary amount provides for a specific minimum level of damages. This sum certain amount then provides a Chinese court with the basis for a pre-judgment seizure of assets. A credible threat of your seizing your Chinese counterparty’s assets greatly increases the likelihood of that Chinese company abiding by your NNN agreement and of your being able to quickly bring the Chinese company to heel if it does not. Third, Chinese courts are quick to freeze assets up to the amount set forth in the damages provision.

An NNN agreement must include a sum certain contract damage provision that a Chinese court can and will enforce by ordering seizure of the defendant’s assets. Care is required, however, because the Chinese legal system does not allow for punitive damages or extensive consequential damages. It is therefore important to set the contract damages in your NNN Agreement at an amount that reasonably substitutes for the damages that result from a breach of the agreement. See China Contract Damages Done Right.

Because Chinese companies know that breaching a well drafted China-specific NNN Agreement will likely lead a Chinese court to  freeze their assets, we typically encounter the following three responses from Chinese companies to our NNN agreements:

1. A few Chinese companies refuse to sign. These are the companies that planned to steal IP from the very beginning. This sort of situation has in the last few years become increasingly rare.
2. Some Chinese companies will enter into serious discussion about what they believe should be excluded from the NNN Agreement. Our China lawyers usually view this as a positive because it indicates the Chinese company is taking the NNN Agreement seriously and it often generates productive discussions regarding technical issues.
3. Most Chinese companies execute the NNN agreement and then treat their NNN obligations seriously. This does not mean every Chinese company will abandon years of bad practice and begin behaving well. But it usually means that when a Chinese company violates the NNN agreement, litigation is not required. In most cases, a reference to the NNN agreement and the credible threat of litigation/asset seizure is enough to induce the Chinese company to step back into line.

Draft Your NNN Agreement to Avoid Litigation

The above illustrates the general approach our China lawyers take when drafting any agreement involving China. We do not want to see our clients have to litigate. To reduce the likelihood of having to go to court, it is essential the Chinese side believe it would be relatively easy for you to sue and prevail. A well-crafted China-specific NNN agreement does exactly that.