Because of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a super fast general answer and, when it is easy to do so, a link or two to a blog post that may provide some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.
China’s biggest companies, both private (like Alibaba and JD.com) and State Owned (SOE) or quasi-government owned (like Shanghai Auto and CNOOC) are on buying sprees, be it for other companies or for technology. Our firm has represented a number of foreign companies (so far, mostly U.S. and European) on some of these deals and one of the things we are finding that our clients often believe is that because they are doing these deals with such big and well-known Chinese companies, certain rules for avoiding risk do not apply.
Those rules do apply and here’s the kicker: these deals are virtually never with the big and well known company and oftentimes this is not clear until the first contract draft is written. Instead, these deals are with newly formed entities that these big companies form just for this one deal. These newly formed companies usually have virtually no history and, most importantly little to nothing in the way of assets. Sometimes we can get these China mega companies to guarantee the deal but most of the time we cannot. So most of the time the reality is that — technically — our client’s deal does not have big company type safety, just big company prestige.
So the answer to the quasi-question is that these deals with big companies are really all over the map in terms of risk and nothing should be assumed.
In part one, Negotiating With Chinese Companies: Be The Rabbit, we talked about using the Zen technique of “being the rabbit,” which in Western terms translates mostly into just being patient, hanging back and letting the Chinese side start negotiating with itself. In part two, Negotiating With Chinese Companies: Walk, Don’t Look Back, we talked about how Western companies must 1) convey a willingness to walk away from the deal and 2) actually be willing to walk away from the deal. In this third part, we again emphasize the need to patient, this time when facing the common Chinese company negotiating “death by a thousand cuts” tactic.
Chinese companies, both SOEs and privately held, are in a mad dash to purchase foreign technologies on the cheap. And when I say technologies, I mean just about every technology possible: health care, internet, Internet of Things, computer hardware, software, manufacturing. It is truly endless. I feel like I am in the middle of a gold rush. A severely flawed gold rush.
What are the flaws?
The biggest flaw is that the default option for these Chinese companies is usually to try to get the technology for literally nothing or next to nothing. And far too often, the foreign company goes along with this.
Let me explain.
The media covers the massive China tech deals. Deals like Midea Group’s $5 billion bid for Germany’s robotics specialist Kuka AG. Those are not the deals my firm is seeing. Not at all. The deals we are seeing involve — at least half the time — second and third tier technologies held by foreign companies on an economic precipice. The China company swoops in and offers a lot of money for the technology. The foreign company then retains us and we then explain why what looks like such a good deal is, in reality a terrible deal. The foreign company then tells us (and far too often the Chinese side) how if it doesn’t make this deal it may have to “downsize” or even shut down. Some of these companies are quite large and quite well known, but their ability to secure additional funding is marginal.
And then over the next few months the two sides negotiate and during that time the Western side reveals — either intentionally or unintentionally, its desperation to get the deal done. And during that time, the Chinese side constantly and unremittingly seeks to exploit that desperation, using the following tactics.
Death by a thousand cuts. The Chinese company starts out saying it will pay $20 million for the technology, as though that is the extent of the deal. Then it drafts some vaguely worded MOU that mentions $20 million in passing, but is nothing like a straight up deal and when analyzed either makes no sense, is clearly not achievable under Chinese law, or will almost certainly lead to the Western company never getting paid. When the Western company complains about this, the response of the Chinese company is usually to go silent for a few weeks and then to suggest to the Western company that it modify the nonsensical/unworkable MOU. Our advice is to seize that moment by presenting a carefully drafted and realistic Chinese and English language contract that actually reflects the parties’ earlier discussions. The Chinese company usually will wait a few weeks and then respond with a reasonable number of objections to the contract. The foreign company and the Chinese company negotiate on these issues and reach resolution. The foreign company quite naturally then assumes that the negotiation process is complete and expects the next steps will be to execute and then implement the contract.
Instead, the Chinese company puts forth a brand new set of contract objections. The parties again negotiate and again reach resolution. The foreign company again assumes that the next steps will be to execute and implement the contract. But the Chinese company returns yet again with a new list of contract objections, including objections to some of the matters already decided on in the previous rounds of negotiation.
If the Chinese side has been forced to concede on important matters, this death by a thousand cuts tactic will likely continue until the Chinese side gets most of what it wanted from the beginning.
In negotiating the initial objections from the Chinese side, the foreign side will usually have made concessions that weakened its position, all as part of the normal negotiating give and take and all done on the assumption that both sides would be making concessions to consummate the deal. However, when the Chinese company comes back with new demands, it has already extracted concessions from the foreign side and it is now seeking additional concessions.
The Chinese company engages in this tactic to wear down the foreign company to that point that it concedes on important points to get the deal done. The Chinese negotiators are often quite clever at mixing important issues together with trivial issues and hiding important changes with seemingly minor changes in wording. Fatigue and changing negotiation staff from the foreign side can allow these matters to slip through at the very end of the negotiation process.
In the last year or so, we are seeing a new tactic, where the Chinese company will send back a revised contract in just badly written English, and without any redlining that would allow us to quickly see the changes that have been made to it. This new tactic has all of a sudden become quite common and it is an ideal way for the Chinese side to throw yet another cog into the negotiations, especially since Chinese is usually the official language of the contract and especially since their written English is almost never clear enough so that we can understand everything and it is virtually never clear enough so that we can use it in a real contract. When this happens, our typical response is to say, “no.” If you don’t have the time or the ability to put it into two languages, send us just the Chinese and send us a redline version showing all of your changes. We are not going to charge our clients lawyer rates trying to parse out what you have given us.
You can usually avoid the death by a thousand cuts tactic by being firm with the Chinese side. One good counter-tactic is to make clear (preferably in writing and in Chinese) that your Chinese counter-party has only one chance to comment so it should make sure that all of its comments and objections are included in its first communication. The Chinese side typically ignores this rule and will still come up with additional comments even after having been told that they will be ignored. The way to deal with this is to live up to your own commitment by telling the Chinese side to “take it or leave it.”
More to come….
Many many years ago, we helped a foreign school “conglomerate” set up a number of schools in China and due to “word of mouth” we have been getting calls and emails regarding China school set-ups ever since.
Many of those communications come from ESL teachers who see a need and want to fill it, but truth be told this is by no means an easy or inexpensive business and so only a tiny percentage of those who kick our tires ever get past that stage.
Because of all the “I want to start a school in China” tire-kickers, we now have a template email to alert them right up front to the difficulties of successfully doing so and I figure that putting it up here could prove useful to at least some of our readers, so here goes:
A School for Children of Foreign Workers is the only type of school that China allows to be 100% foreign controlled and owned. The path for this is sort of school is as follows:
- Start with extremely strong local government support for the school and an established off-shore education institution.
- Register a consulting/technology WOFE with USD$500K+ registered capital and the relevant business license.
- Lease/purchase a facility and fit-out to meet school-level fire and safety regulations.
- Spend 2+ years working on the provincial education bureau license application process.
Note: This sort of school can hire foreign and local teachers, and all relevant staff needed to run a school.
If you are wanting to run an “English training center” (basically for English tutoring), the path we see foreigners go down is usually the following:
- Start with local government support for the training center.
- Lease/purchase relevant commercial space.
- Register a consulting WOFE with foreigner/foreign company as sole investor, and with a fairly generic business scope (local AIC’s do not like to give scopes that permit education activities).
- Open the English training center and hope nobody cares to check your business scope carefully. We have heard of centers getting closed within weeks of their opening and we have heard of training centers remaining open for years and years.
Note: With this method, you cannot officially hire teachers, only consultants or other positions relevant to running a consulting company. Work visas for such “consultants” are often held up due to the skepticism of local officials and a typical foreign teacher’s lack of qualifications to be an actual “consultant.”
If you are trying to use this consulting business to run an actual school it won’t last long unless you are seriously protected by local government. Note that if you are doing this with a “Chinese partner,” it will be your partner with this relationship and it is quite common for the Chinese partner to boot out the foreigner once the foreigner is no longer needed. Because the whole enterprise is so sketchy to begin with, you likely will have no recourse once this happens. Note also that government officials in China change and change often and the new officials generally try to wipe this sort of slate clean.
Registering a fairly generic consulting WOFE would be easy but you would be at big risk for being able to maintain it. Registering a consulting WOFE with something educational in the business scope would be very difficult — but we have done this before — and far less risky once registered. Registering an actual school is a long term and very expensive project, but possible if you have the funding and a will to achieve it.
Where do you fit in the above?
During the first years of this blog (mostly from 2006 to 2010) we wrote often about the power dynamic between Beijing and China’s provinces and we also wrote constantly about China’s second tier cities. Since 2010, and especially in the last few years, we barely touch upon these subjects. What has changed? A lot.
In our early days, we were big believers in foreign investment going into China’s second tier cities and we were also witnessing China devolving power to its provinces. Back then, when people would ask us in what cities we did most of our work, we would usually estimate about 30% n Shanghai, 20% in Beijing, and the other half throughout China (but mostly in Shenzhen, Guangzhou, Xi’an, Nanjing, Tianjin, Xiamen, Qingdao, Dalian, Suzhou, Chongqing and Chengdu). Now, our answer would be more like 30% Shenzhen (China’s technology and Internet of Things center), 30% Beijing (China’s software and media center), 30% Shanghai (China’s center for corporate locations) and maybe 10% “other.” When I ask other China lawyers outside my firm about the geography of their China legal work, they report much the same.
So it is now mostly Beijing and Shanghai and Shenzhen, but really only Shanghai and Beijing are true “centers” in the sense that it is almost exclusively in those two cities where one will find the best lawyers and the best accountants and the judges and the best consultants and the best. . . . Shenzhen is mostly for manufacturing, not services. If a client of our firm seeks a recommendation for high level assistance, we virtually always refer them to someone in Shanghai (if they are located there or nearby) or in Beijing (if they are located there or nearby or maybe not so nearby.
And when it comes to government, Beijing is obviously the lead city, and that is truer today than five years ago. There was a period where Beijing was increasing the authority of jurisdictions outside the capital, but in the last few years — at least with respect to the sort of China legal work in which our firm gets involved — we are seeing authority shift back to Beijing. I thought about that today after reading a Guardian article, entitled, China punishes officials over sewage in first environmental case of its kind. This article highlights how Beijing is more strongly enforcing its laws/positions as against the provinces:
Chinese prosecutors have successfully sued a county environmental agency for inadequately punishing a sewage firm that produced dye without appropriate safeguards – the first such public interest case against a government department.
The Supreme People’s Procuratorate, China’s top prosecutor, said prosecutors had successfully proved that an environmental protection department in Shandong province had committed “illegal acts” in its dealings with the Qingshun Chemical Technology Company.
I have little doubt that this lawsuit was driven by Beijing or, at the very minimum, approved from there. It very much reminds me of what we have been seeing on the WFOE front for the last few years. What we are seeing is an increase in WFOEs being shut down after audits from Beijing reveal that they should never have been registered in the first place. We are learning about these via calls and emails from some of the companies that years ago chose not to use our law firm for their WFOE formations because we told them that what they were proposing for their WFOE would not work. In pretty much every one of these cases, the foreign company assured us that the Chinese company which with they were working had the “power” to get their WFOE approved, to which our response was and still is always: “great, then you should use them for the WFOE formation. But just as a warning, just because a WFOE gets formed does not mean it cannot and will not be shut down when Beijing or a new government sees that it should never have been formed in the first place.
A couple months ago, my firm opened an office in Barcelona, headed up by Nadja Vietz, who joined our firm (in Seattle) way back in 2004. Nadja is licensed to practice law in Spain, Germany and the United States (Washington State) and she oversees a Spain lawyer and a Spain business professional. Truth be told, we chose Barcelona as our European beachhead not after having analyzed a slew of other city options, but simply because Nadja had chosen to live there. But ex post facto, I have come to realize that it may just be the perfect city for us. It is well-located as within Europe, it is moderately priced (at least as compared to London or Brussels or Paris or Luxembourg or even Munich) and it is incredibly international.
I mention Barcelona because before we opened an office there and before I started communicating so often with all sorts of professionals there, I failed to realize how seriously Catalonians view their independence. I was under the mistaken impression that Catalonia’s professional class would uniformly oppose independence for economic and business reasons, but whenever I broach the subject of an independent Catalonia, one of the first arguments I hear in favor of it is the economic/business one.
England is obviously facing similar issues right now regarding Brexit. And I have to confess that after having read dozens of articles predicting either financial ruin or a financial renaissance should Britain leave the EU, I am of the view that nobody really knows and that either way the impact will likely be far less than predicted. I am fairly certain of one thing though and that is that whether Britain stays or goes, Brussels’ power over its provinces (the EU countries) will probably never reach a level greater than today and will almost certainly decline.
So I just find it interesting that just as so much of the world is seeing power in the center being questioned and/or weakened, China seems to be moving in the opposite direction.
What are your thoughts about that?
Our China lawyers have seen a spike in queries from foreign companies encountering problems getting paid by Chinese companies. I’m talking mostly about private Chinese companies without affiliates or assets abroad. This is the first post in a series I will be writing on the new issues in getting money out of China.
An excuse commonly offered to the foreigner by the Chinese company is that the rules have recently changed so foreign payments are no longer possible or practicable. Another one is that the Chinese company is simply not allowed to send more that $50,000 at a time or even $50,000 in total each year. Is there any truth in this?
The underlying regulations have not changed and there is no limit on the amount that can be remitted abroad by a compliant Chinese company. But Chinese banks are becoming much stricter with certain types of remittances. This new strictness has come about in an effort to limit fraudulent capital outflows and to make sure tax is paid in China before money leaves the country.
Chinese law generally requires a Chinese company to obtain a “tax certificate” from its local tax bureau before more than $50,000 worth of RMB can be converted into a foreign currency and remitted abroad. As the name might suggest, the certificate confirms that the Chinese company has made all necessary tax payments on the money or has some kind of exemption for the money. To obtain the certificate the Chinese company needs to submit copies of the relevant contracts (and oftentimes invoices) and provide particulars of the transaction. The tax certificate must be presented to the foreign exchange bank before the payment transaction occurs.
The regulations provide for a blanket $50,000 exemption from approval. No proof or justification is required, up to the $50,000 limit. However, in June of last year, Chinese banks began arbitrarily denying requests for RMB conversion of amounts below the $50,000 limit.
Sometimes, the real problem, especially with larger remittances, is simply that the Chinese company can’t get a tax certificate, or doesn’t want to get a tax certificate, because that would require it to pay tax it wasn’t planning on paying. To be fair, problems sometimes arise when the Chinese company genuinely wants to make a remittance and is prepared to pay the applicable taxes. These problems vary depending on the type of payment. They mostly affect payments for services, royalty payments and Foreign FDI or M&A payments. Payments for the purchase of goods are generally not as complicated, so long as the foreign side has its own paperwork in order as well.
In my next post I will look at the delays and complications affecting different types of payments.
One of the more distinctive aspects of China’s trademark system is its unique interpretation of the Nice Classification system. China divides each Nice class into subclasses, and treats each subclass as a discrete unit. A trademark registration gives the owner rights in the covered subclasses, but virtually no rights in any other subclasses. (For further discussion of this feature, see China Trademarks. Register Them in China not Madrid.)
I was thinking about this the other day when I read about the U.S. trademark dispute between Dr. Pepper Snapple Group, which currently owns the Crush line of beverages, and the Denver Broncos football team, which currently owns the Lombardi Trophy. The Broncos filed an application to use “Orange Crush” on (1) shirts, caps, and sweatshirts (Class 25 goods) and (2) football-related education and entertainment services (Class 41 services). Dr. Pepper was not happy about this, and in a brief filed on May 31 with the USPTO, argued that their various “Crush” marks have such strong common law rights that allowing the Broncos’ application would dilute the Crush brand and cause consumer confusion.
Dr. Pepper Snapple should be grateful that they’re not in China, where their opposition would be dead on arrival. China is not a common law country and does not recognize common law rights to trademarks. The way to get trademark rights in China is to file a trademark application in the classes (and subclasses) that you want covered. The main exception is for well-known trademarks, but it is extremely difficult to prove you have a well-known trademark.
I just checked and right now no one owns the rights to “Orange Crush” in China in any category. The Denver Broncos could file the same applications they filed in the US and Dr. Pepper couldn’t do a thing about it. (The Broncos might face opposition from other rights holders, like the Shanghai trading company that has registered “Crush” in Class 25, but that’s a different matter.) Then again, if some random person files an application tomorrow for “Orange Crush” in Class 41, the Broncos couldn’t do a thing about that either.
If I were advising the Broncos, I would tell them that if they have designs on using “Orange Crush” in China as part of their long-term branding strategy, they should run, not walk to the CTMO and file China trademark applications for “Orange Crush” in a variety of classes. And I would give the same advice to Dr. Pepper regarding “Crush” (and maybe “Orange Crush” as well, if it’s that important to them). It’s no mystery why companies like Starbucks and Disney have started registering their most important trademarks in every single class and subclass in China. After spending years railing against the idiosyncrasies of the Chinese trademark system, these companies are finally using them to their advantage. The only mystery is why more companies aren’t following suit.
But maybe ignoring China is a calculated move by the Broncos and Dr. Pepper, since everyone knows Tang is the orange drink of choice there.
Just read The Future of Manufacturing in China: Three Big Trends over at ChinaImportal. (h/t to Quality Inspection) and I agree with 88% of it. The post does an excellent job of explaining where China manufacturing is today — with an emphasis on what so many got wrong in their predictions on where China manufacturing would be today — along with where China manufacturing is going. The post does this by breaking down into three main themes:
- Production will remain in China, despite increasing costs
- Manufacturing is becoming as accessible to Startups and Small Businesses, as Software development
- Importers will need to excel at branding and marketing to stay in business
I will examine each of these in turn.
1. Production will remain in China, despite increasing costs.
ChinaImportal talks about how Chinese suppliers are facing increased costs, among which are a rapidly improving Chinese tax collection system, but despite this, “China’s East Coast grew into an even stronger manufacturing base. Shenzhen is the brightest shining star, and has cemented its position as the World’s center for manufacturing.” Shenzhen is today “an ecosystem that cannot be simply transplanted. ChinaImportal correctly notes how this reflects that “China is losing out in some areas, but gaining in others.” I agree, and for my take on this, check out China Manufacturing: Cha-Cha-Changing….
ChinaImportal sees China eventually losing its cost advantage entirely, “compared to the US, EU and Japan, due to cheap robotics, AI and 3D printing. But that’s at least two or three decades away.” Okay.
2. Manufacturing is becoming as accessible to Startups and Small Businesses, as Software development
ChinaImportal then argues that manufacturing in China is becoming so routine and so easy that even a college student can do it:
Today, a product can get financing on Kickstarter. Then, Alibaba comes in with their Trade Assurance program to secure the transaction with the supplier.
Once ready for shipment, just book a quality control online at Sofeast.com, and get a free shipping quote from Flexport – directly delivered to an Amazon FBA warehouse.
In the last few years, the entire supply chain has moved online, and this is just the beginning.
I vehemently disagree with important parts of the above. Let me break it down, claim by claim:
- “Today a product can get financing on Kickstarter.” This is indisputably true, as far as it goes. But as we recently screamed from the rafters in China, Indiegogo, Kickstarter, The Internet of Things, Marshall Goldsmith, and Suing Your Lawyers and Sourcing Agents Because It Is Getting Really Really Bad Out There and in Worthless China Contracts: First, Let’s Sue All The American Lawyers and in China and The Internet of Things and How to Destroy Your Own Company and even way back in 2014 in Kickstarter And China Manufacturing. You Are So Wrong On Your China Risks, having Kickstarter funding does not mean a thing when it comes to protecting your intellectual property. All I can tell you is that about once a week one of our China lawyers has to tell some recent college graduate with $250,000± in Kickstarter funding that he or she no longer has much of anything because they have relinquished it to their China supplier. And once the China supplier owns your essential IP, your China supplier will be free to double the cost of manufacturing what you may still consider to be your product, and they will.
- “Then, Alibaba comes in with their Trade Assurance Program to secure the transaction with the supplier.” Wrong again. In the last six months or so I personally have had at least four companies come to me after having ordered between $25,000 and $250,000 in product and then received bad product but little to no compensation from Alibaba’s Trade Assurance Program. I also know that at least one of these companies is talking to lawyers about pursuing a class action case against Alibaba for “acting as though it is providing insurance, when it really isn’t doing anything of the sort.” I would love to hear from others out there regarding their experience with Alibaba’s Trade Assurance Program? Has Alibaba treated you fairly? Did it pay you what you believed you were owed? Or did it essentially tell you to go pound sand?
- Once ready for shipment, just book a quality control online at Sofeast.com, and get a free shipping quote from Flexport – directly delivered to an Amazon FBA warehouse. I buy this.
- “In the last few years, the entire supply chain has moved online, and this is just the beginning.” I buy this.
3. Importers will need to excel at branding and marketing to stay in business
I completely agree with this, or as ChinaImportal puts it:
As manufacturing becomes accessible to (almost) everyone, the market is becoming flooded with products.
The core of every business is the product, or service, it sells. However, a product is only as good as the marketing and sales processes that supports it.
The future belongs to those businesses that can not only bring a product to market, but also master the art of product branding, customer service – and online marketing.
In fact, these skills are combined more important than the product itself.
ChinaImportal then correctly notes how “what makes a business successful in the OEM manufacturing game is irrelevant when selling on Amazon, and other B2C online channels” ChinaImportal then points how that since so “many [China] suppliers struggle to respond to emails within a week, they are nowhere near having the ability to last more than a month on Amazon.” ChinaImportal is absolutely right on this as well. But ChinaImportal is also right to point out that the competition from China is slowly getting tougher:
That said, the younger generation in China has a much better understanding of branding, and the importance of solid customer service.
The question is how much of an advantage they will have in the future, given that they have better access to manufacturers than their American and European competitors.
That advantage is not negligible, but an understanding of the target market has been always more important, than an understanding of the supplier that makes the product. This holds true, regardless of where in the world you do business.
What are you seeing out there in the world of China manufacturing?
I previously wrote how an employer would be required to pay statutory severance to an employee who unilaterally terminated his or her employment contract because of employer abuse. One such ground is the employer’s failure to provide necessary labor protections for employees. For example, China’s Law on the Protection of Women’s Rights and Interests explicitly prohibits sexual harassment against women and the law further provides that female sexual harassment victims may file a complaint with their employer and/or with the authorities. Nonetheless, not all female employees have prevailed in getting the employer to pay.
Let’s take a look at a case from Zhejiang province.
Employee (plaintiff) entered into an employment contract with her employer (defendant) and thus established an employment relationship with the employer in December 2011. In May 2014, the employee found some strange fluid in her mug on her desk and suspected it was semen and reported this to her Employer. The employer contacted the police department and pulled surveillance video. The next day, the plaintiff/employee took the surveillance video and the mug to the local police. That same day, a male company manager who worked in the same department as the suspect asked the employee who had found the mug on her desk not to press charges so that he wouldn’t lose face. The following day, the suspect went to the police and confessed to everything. The police eventually imposed an administratively detained the suspect for three days as punishment, but brought no criminal charges against him.
The following month, the female employee provided notice to her employer of her intention to terminate the employment contract due to the employer’s failure to provide labor protection and labor conditions required under the law. The employee demanded three months’ statutory severance but the employer refused to pay. The employee filed a claim against the employer at the labor arbitration center but she lost. She then filed a lawsuit against the employer in the local court.
The court first acknowledged that the Special Rules on the Labor Protection of Female Employees and other relevant laws and regulations regarding protection of women’s rights require an employer prevent and stop sexual harassment against female employees. But the court then went on to say this does not make employers strictly liable for every illegal act that occurs at the employer’s workplace. The court then ruled that even though the suspect was an employee of the defendant, the suspect committed the illegal act himself and it was his act that directly and proximately caused plaintiff’s emotional stress, which led to her leaving the employment. According to the court, the suspect had acted completely on his own, and the employer had no way of predicting and controlling the suspect’s action. After the employer received the employee’s report, it handled the incident as best as it could by timely contacting the police in a timely and pulling the surveillance video. The court went on to hold that the department manager who asked the female employee to withdraw her complaint about the incident was not representing the employer with that request and thus his actions also did not constitute employer action. Finally, after the police had punished the suspect, the employer terminated him. So there was no factual or legal basis to support the employee’s demand for severance when she unilaterally terminated the employment relationship with the employer. Thus the employee lost at the court level as well.
How would a U.S. court have handled this same case? To get an answer to this, I turned to my friend, Ada Wong, a Seattle-based employment attorney licensed in the states of Washington and California. She surprisingly responded by saying that a Washington State Court would probably have handled the case quite similarly:
In Washington, employers also have a duty to prevent workplace harassment, including sexual harassment. However, employers are not automatically held liable for every employee’s actions. Under federal law, an employer is subject to vicarious liability to employees for an actionable hostile work environment created by a supervisor. It is unclear from the facts of this case whether the suspect/perpetrator would be considered a “supervisor” so as to render the employer strictly liable for that person’s actions. If the perpetrator had held the power to hire, fire, demote, fail to promote, etc., then that person would likely have been considered a supervisor for this purpose.
If the employer had reason to know – “knew or should have known” – that the perpetrator was engaging in this type of behavior or was going to engage in this type of behavior, and still failed to prevent it, then the employer could be held liable for allowing the perpetrator to carry out his actions.
The employer took the correct action by immediately reporting it to the police and starting an investigation by pulling the surveillance video.
In terms of the department manager who requested that the harassed employee withdraw her complaint, it is unclear whether he represented the employer when he made that request. If he did this while at the office during working hours, then plaintiff could argue that she was under the impression that if she did not withdraw her complaint, she could face adverse employment action. Had she reported this to her employer and was terminated or faced adverse employment action, that would have provided her with additional grounds for a lawsuit. The department manager’s telling the plaintiff/employee not to press charges was clearly inappropriate, but it may not give rise to a claim against the employer.
If this matter were heard in a Washington State Court and there had been no evidence of any prior notice of the suspect’s inappropriate behavior, the plaintiff employee likely would not prevail on a sexual harassment claim against her employer for the suspect’s action, especially because the employer took appropriate measures, including contacting the police and terminating the suspect upon learning of the incident. If plaintiff employer could show that the department manager was acting in his supervisory capacity when he made the request for her to withdraw her complaint, then the employer may be deemed liable.
This case is unusual in that the suspect’s action was so bizarre that it is hard to imagine the employer could or should have foreseen it. Still, the Chinese court never even discussed the “notice” element: did the employer have reason to know (or even have an inkling) that the perpetrator would do something like this?
What is also unusual about this case is that the employer chose to spend money fighting this battle in a court and thereby allowing all of this to become public, rather than just paying the employee her three months.
What do you think?
Big media today has been covering Apple’s BREA design patent dispute with “a small Chinese competitor” and I woke up this morning with my inbox filled with emails from financial analysts and reporters clamoring to talk with me about this news. I assume the other China lawyers at my firm are being similarly inundated. This is obviously huge news and for more on this story, check out the following:
- Washington Post. Beijing panel backs Chinese firm in iPhone design dispute with Apple
- Wall Street Journal. Beijing Regulator Orders Apple to Stop Sales of Two iPhone Models
- Bloomberg. Apple IPhones Found to Have Violated Chinese Rival’s Patent
But first, everyone calm down and let me explain.
I do not know anything at all specific about Apple’s case. Not a thing. My law firm does not represent Apple on its IP matters, nor do we represent the Chinese company with this patent claim. Additionally, I have not looked at a single pleading in this case, nor have I discussed this case with any of the China IP attorneys in my firm who may (or probably not) know more about this case than I. This post is based on what we have seen (especially lately) happening with China design patents, which is a whole lot.
In the last six months or so, we have gone from dealing with maybe one China design patent matter a year to at least one a month. We cannot pin down this massive acceleration in design patent matters on any one thing and so we simply think that word has gotten out among Chinese companies regarding the effectiveness of engaging foreign companies in design patent disputes.
What exactly is a China design patent? China’s design patent law design is defines a design as a shape, pattern, or combination thereof or the combination of a color with a shape and pattern, with an aesthetic appeal and for industrial application. If you think this definition is incredibly vague and potentially broad enough to drive a truck through, you would be right. On top of this, China’s patent office does not “review” design patents before granting them. Or, as I love to tell our clients over the telephone, “I could probably secure a China design patent on the blue socks I am wearing right now.” When I say that, I am being intentionally dramatic, but I honestly believe my chances of securing such a design patent are not that bad.
The other things you should know about Chinese design patents are that the patent grants its holder exclusive use of the aesthetic features of a product not its functioning portion. In other words, the patent is on how the product looks; its external appearance. Not kidding, but it is quite possible that the small Chinese company with the mobile phone design patent could use its design patent against any cell phone company with a product that looks like an iPhone.
But let’s step back and look at what it really means to have a design patent, and I will do that by explaining (in a compilation form) the design patent cases our China attorneys have recently been handling.
These cases typically start with a phone call from a Western company telling us that some company (usually a company it already knows and usually either its manufacturer or a competitor) just contacted the Western company (or the Chinese company that makes the Western company’s product) and said that the Western company’s product is violating the Chinese company’s China design patent. The Chinese company then threatens to sue the Western company for patent infringement damages and to block any of the Western company’s “infringing” product from leaving China. Needless to say, the companies that call us on these matters are more than a little bit concerned.
Though I am not going to claim that these are pleasant situations, I will claim that they are not nearly as bad as they sound. I have heard that China issues around ten times more design patents than the United States patent office, which reinforces my contention that I could get a China design patent for my blue socks. There is no substantive examination of a design patent application in China. Instead, all you really need to do to get a China design patent is to complete your design patent application properly. So if I complete the design patent application on my blue socks, and attach a proper and appropriate drawing of them, along with a proper power of attorney and I make the right claims regarding my having designed my blue socks and regarding their being of a new design, I almost certainly will get my design patent.
BUT, my blue sock design patent will be as weak as a kitten. And it is for this reason why China design patent actions are not nearly as scary as they first appear and why I am calling for nobody to panic on Apple’s behalf either.
In the cases we handle nobody has yet actually had customs block any product from leaving China. The reason is because China customs generally requires a party seeking such a block to post a substantial bond. That substantial bond then becomes available to the party whose product has been blocked by customs.
The difference between the cases we have handled and the Apple one, however, is that in our cases the Chinese companies threaten to get an order blocking our client from having its product made in China, but they never do. They never do because they know the cost of doing so is high and the likelihood of their getting such an order and having that order stick is very low. I read somewhere once that something like 70 to 90 percent of all Chinese design patents get invalidated when challenged. These Chinese companies know that if we were to challenge their design patents we would prevail, so why spend big money only to lose in the end. The Chinese company’s power comes from the design patent threat, not from reality.
Based entirely on our own history with China design patents, I am guessing Apple will prevail in the end.
What’s the best way to nip design patent hijacking? Register your design patent first.
NOTE: I wrote the above post in 15 minutes because I think it important to get out there fast. I prioritized speed above quality and I apologize for its sloppiness.
Our lead China media and entertainment lawyer out of Beijing, Mathew Alderson, was recently interviewed for a VICE Sports story by Joshua Bateman, entitled, The UFC With Chinese Characteristics. The full text of the interview is below, with the publisher’s kind approval.
Alderson: I understand the UFC [Ultimate Fighting Championship] business is to be conducted by a Nevada LLC. The company promotes and produces mixed martial arts events broadcast free-to-air or through subscription services. I understand the company to have a broadcast deal with Fox Sports. The company is reportedly in discussions with Chinese buyers or investors. You are therefore interested in the effect Chinese ownership or investment may have on the management and regulation of the company.
At the outset, it should be appreciated that Chinese ownership of the Nevada LLC (or any other non-PRC company) would not, of itself, bring the company under Chinese regulation. The company would continue to be subject to regulation in the place in which it is established (Nevada and the United States) and the place or places in which it conducts business. The UFC would only become subject to Chinese regulation to the extent it conducts business in China. As a foreign company, the UFC could only promote its events in China with the assistance of a local partner with the necessary permits and licenses. Production of TV programs in China would also require the assistance of such a partner, probably a local co-producer. This is because foreign investment is restricted in the sectors in which UFC operates.
I answer your questions with these introductory remarks in mind.
VICE Sports: Is it possible Chinese regulators would view the UFC as a media company, and that would impact investment opportunities or how the company is regulated in China?
Alderson: Yes, it is possible because the UFC business model involves promoting live events and producing and broadcasting TV programs. These are sectors in which foreign investment is restricted. The impact would depend on whether the UFC established an entity in China and whether that entity is wholly Chinese or partly foreign-invested. A foreign-invested entity would attract greater scrutiny. The impact would be less if the Chinese market were approached by licensing content into China.
VICE Sports: If the UFC were to be acquired or were to accept investment from a Chinese company, would there be political/regulatory pressure in China for the company to alter its management or board structure to have more Chinese representation?
Alderson: Again, it would depend on where the company is operating and where the investment is made. There would be more scope for such pressure if a unit of the company were established in China, whether as a fully Chinese company or as a foreign-invested company. It would be much harder for Chinese owners to exert, or be subject to, this kind of pressure in holdings outside of China; although, if they had the necessary voting rights, Chinese owners could — like any investors — control or at least influence management abroad.
VICE Sports: If current UFC ownership does not sell the company but instead attempts to expand in China going forward, could they do so on their own or would they most likely need to join forces with a Chinese partner?
Alderson: They would need Chinese partners because foreign investment is restricted in the sectors in which they would likely be operating. The most likely business models are joint ventures and co-productions.
I spend a huge portion of my waking hours talking to companies doing business in China or looking to do business in or with China. One of the things I virtually always try to discuss with all potential and actual clients at least once (and usually during our first conversation) is the need for them to protect their IP in China. Maybe one out of fifty of our clients has no IP to protect, but the rest do and it is surprising how many of them do not realize the need for them to do so when dealing with China.
Above of all else, I talk about the importance of filing for trademarks in China and how if you don’t get your trade names and logos registered as trademarks in China, someone else eventually will and then you will be facing all kinds of trouble. And then I talk about the trouble. That is nearly always enough to convince Western companies of the need for a China trademark.
But the other day I was talking with a very young, super-smart owner of a start up tech company and after I recited my “trouble speech” on China trademarks, he asked me why trademarks are important. As he put it, “I understand that someone else could end up with our trademark in China, but why are trademarks so valuable in the first place?
“Great question,” I responded and then asked him what kind of car he drives. He said BMW (I was all but counting on this) and then I proceeded to ask him if he knows or even cares how many patents BMW has on the car he drives and of course he did not. I then asked him what then made his BMW distinctive enough that he would buy that car over, let’s say a Honda. His response was that he knows BMW makes great cars. I then explained that he knows BMW makes great cars and he knows his car is a BMW because it is the only car company in the United States (and in China too, I presume) that can brand its cars “BMW.”
Fortunately, he seemed satisfied with my answer. But, really, what makes a trademark so potentially valuable? Some or all of the following:
- Your trademark can give your business its identity.
- Your trademark can give your goods or services brand recognition.
- Your trademark distinguishes your goods or services from others in the marketplace.
- Your trademark can be used to stop others from using (infringing on) your name or your logo.
- Your trademark can be used to show that you own a particular name or logo.
- You can license or sell your trademark.
Did I miss anything?
On Tuesday one week ago, the Financial Times’s Beyondbrics blog published a very interesting piece by China First Capital’s Peter Fuhrman on innovation in mainland China as compared to Taiwan. The piece focused on the push-back Fuhrman experienced after an article he co-wrote holding up a Taiwan-based company (Largan Precision) as an example of a high-tech, high-net-profit business of the kind mainland China has yet to produce. The thrust of Fuhrman’s piece — that innovation is something that cannot be simply created overnight by government mandate — is something with which I heartily agree, but some of the things he says about China’s patent system bear further discussion.
First there’s this:
There are specialist patent courts now to enforce China’s domestic patent regime. But, the whole system is still weakly administered. Chinese courts are not fully independent of political influence.
And anyway, even if one does win a patent case and get a judgment against a Chinese infringer, it’s usually all but impossible to collect on any monetary compensation or prevent the loser from starting up again under another name in a different province.
Though it’s generally true that China’s courts (and the courts of many other countries) can be subject to political influence, at least in my experience, in 95%, maybe 99% of cases this will not be an issue for anyone attempting to enforce patent rights in mainland China. If this were truly a common factor, one would expect China court decisions to show a bias against foreign litigants, but studies have failed to find any such bias. Yes, it is possible for low-level patent infringers to simply abscond, avoid paying damages, and set up elsewhere — I would say this is especially an issue for trademark infringement — but this is rarely an issue for the much larger companies that are typically the subject of patent infringement cases. Though it’s difficult to make hard-and-fast judgements about which countries are better at enforcing IP rights, I have not found any major difference between Taiwan and mainland China in this regard. If Taiwan is better, it is not overwhelmingly so.
Then there’s this:
Another troubling component of China’s patent system: it awards so-called “use patents” along with “invention patents”. This allows for a high degree of mischief. A company can seek patent protection for putting someone else’s technology to a different use, or making it in a different way.
There are two ways to view this statement, to both of which I take exception.
The first is that Fuhrman is talking about so-called “new use” patents, that is patents that claim a new, inventive use of a known article. A classic example of this would include using a known lubricating oil to treat a disease. I think most people would agree that discovering such a new use, where it would not have been obvious (Chinese law is stricter in this regard than say, US law), is exactly the kind of innovation patent systems exist to protect and encourage. It is also possible to patent such inventions in Taiwan and (as far as I know) every other country in the world with a functioning patent system. The same is true of new ways to make a known article. Where the new way is inventive/non-obvious and advantageous, why shouldn’t you be able to patent this improvement?
The second is that Fuhrman is talking about so-called Utility Model patents or innovation (as opposed to invention) patents. Though laws vary between countries that grant Utility Model patents, they are typically designed to protect innovations that do not fulfill the requirements for patent protection (e.g., they may be obvious/non-inventive), but which are still new. The rights granted by such Utility Model patents usually are much more narrow, and the monopoly period is shorter, and they are not examined. Though Utility Model patents can be controversial, particularly because they theoretically can lead to someone being able to file something that, on the face of it, could even cover the wheel (and did, in Australia) utility models exist in many countries that have thriving tech industries, including Taiwan. The fact that so-called “paper-tiger” applications have been filed that appear to cover well-known technology, but which are in fact completely unenforceable, hasn’t deterred innovation in countries with Utility Model systems.
Finally there’s this:
It’s axiomatic that countries without a reliable way to protect valuable inventions and proprietary technology will always end up with less of both. Compounding the problem in China, non-compete and non-disclosure agreements are usually unenforceable. Employees and subcontractors pilfer confidential information and start up in business with impunity.
China Law Blog has written at great length about how to craft enforceable non-compete/non-disclosure agreements so as to protect your business and its IP in China, so I’m not going to say much except that in my experience Fuhrman is only correct about such agreements being “usually unenforceable” in as much as people are using agreements that simply aren’t written so as to be enforceable in China. The same is true of issues with employees and subcontractors; it comes down to the contracts you have had them sign and how you’ve decided to work with them and how you’ve gone about your due diligence.
Bottom line: yes, China does have a patent system that you can use to protect your inventions. No, if anything is holding back innovation in mainland China relative to Taiwan, it is probably not mainland China’s patent system.
* The above is a guest post from Gilman Grundy, a Senior IP Specialist for domestic appliances company Kenwood Ltd, which is part of the De’Longhi Group. The views expressed by Gilman are his own.
When my law firm writes contracts for our American and European clients doing business in China or with China, we write the contracts in both Chinese and in English. We do not translate these contracts into Chinese. Let me explain this distinction because it is a very important one.
We price many of the more routine China contracts on a flat fee basis, and that fee includes our drafting the contract in English for our client’s review, and then putting that same contract into Chinese, as its official language. But every so often, one of our clients will ask what we would charge if we were to draft the contract in “just English” and allow the client’s “fluent Chinese” speaker to translate it into Chinese. I usually respond by joking that we not only do not give any reduction, we actually increase the fee by $5000 to help cover our increased risk of a legal malpractice lawsuit. I then tell them that in reality we simply cannot agree to anyone outside our firm drafting the Chinese version.
Why do I say this?
Because every word matters in a contract and this is as true in Chinese as it is in any language. Words have very particularized meanings in contracts and those meanings are sometimes different in a contract than in real life. Contracts also have terms that have become recognized and defined over time. The only people who can truly know how to use these specialized and particular words and terms are lawyers who know both China’s contract laws and who are completely fluent in written and spoken Chinese. On top of this, it is critical that the Chinese version explicitly reflect our client’s goals. To put it another way, we pretty much never see a “translated” contract that works as intended.
We draft our Chinese language contracts in Chinese so that they can be understood by our client’s Chinese counter-party and so that if there is ever a dispute and our client finds itself before a judge or an arbitrator in China, that judge or arbitrator also can understand the Chinese language contract in the context of Chinese law.
We got a whole new look today. For two reasons. One, we needed to change to look better on mobile device, which is where about half of you now read us these days. And two, because it was simply about time. We tried for a new look that at least has a nod to our old look. We’d love to know whether you like our new look.
If the stars had aligned, our new look would be coming out on our tenth anniversary, but that day passed on January 4, with nary a mention — I forgot!
So consider this post our paean to our longevity. We are often asked what has most changed in China blogging over the last ten years and I always say two things (I often then use my “lawyer’s prerogative and list a few more, but I will not subject you to that today): One, so many of the best China blogs are no more and we find that sad. We used to like nothing more than to highlight a great blog post and then explain the points on which we agreed or disagreed, and oftentimes getting a response to our response as well. We truly miss that. Second — and I am going to have to get all cryptic on you here — but the times have changed in China and that means many of the things on which we used to write we no longer do because to do so would be to invite our not being on a particular country’s internet for a month or two. We long ago made the decision that our highest and best use to everyone is to keep our lights on and so we stay away from that which might cause them to go dark. But hey, if you want to get our more unexpurgated views, check out the China Law Blog Facebook page.
In going back to see when we actually started this blog, I could not help but reading our very first post, back when we were young and filled with spirit and optimism. I am running that post below because though our optimism has flagged a bit, the spirit we sought to convey about this blog for the most part remains. In particular, we still very much like to know what you think. So tell us.
INTRODUCTION TO OUR BLOG January 4, 2016
Why are we doing this?
What exactly will we be doing?
There are more than 4 million blogs. Many of these are about China, including some very good ones. Some of our favorites include Talk Talk China and Simon World for general China information, The China Stock Blog for Chinese stock market information, China Tech Stories for information regarding China’s technology sector, and Journey Around China for travel information. [3-6-2012 Update: None of these blogs still exist so we removed the links]
There is even a superb Chinese law blog, The Chinese Law Prof Blog, but it has a distinctly academic bent and we will not.
We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you about what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy. We want to start a conversation with, for and about the person who wants to know “what is what” in China and the practical aspects of starting and growing a business in or involved with China.
We are not writing for those who want to know more about Section (A)viii of a particular piece of Chinese legislation or the history of that act or the policy reasons behind it. Our site is not focused on the legal scholar.
We want to initiate a discussion regarding the changing laws in China. We will constantly be challenging the various misconceptions the West has about law in China, including that the law in China does not really matter or that guanxi can supplant it.
We will provide information to those who conduct business with or in China as to how they can use the law as both a shield and as a sword. We will give you our insights to achieve practical solutions, while doing our best to entertain.
We know lawyers are not popular, and though we are ourselves really quite likeable, we recognize the need to avoid those things that incite lawyer hatred. In other words, we will strive to avoid legal jargon and namby-pamby language that attempts to camouflage our views or to avoid controversy.
We want this blog to be a place for conversation and even controversy. We expect many of you will disagree with us much of the time and we do not care. We will always strive to avoid boring you or being unwilling to take a stand. We are not going to be afraid of being wrong — in fact, we want you to tell us when and how we are wrong. If you want “lawyer language” or long strings of caveats, you are going to have to pay exorbitant legal fees to get that elsewhere.
Though our focus will be on the interaction of law and business in China, we most certainly will be personalizing this page with our own experiences. We will tell you more than just that the law is this and this is what needs to be done to comply. We will discuss how the laws as written may say one thing, but our experience dictates something else. We will tell you when you need to do more than just follow the law to succeed and we will set out exactly what that something else is. We will estimate the chances for success if one does one thing as opposed to another. You will hear what we have done to succeed for ourselves and for our clients in China and you will hear about where we failed. We will regale you with stories about the Chinese lawyers with whom we work, the foreign and Chinese businesspeople with whom we deal, and even the places we go. There will be times where our lawyer ethical rules will make us unable to name names, but we will always work to tell the full story.
In addition to our discussions regarding what we are seeing on the ground in China, we will post articles and postings from elsewhere, to which we will, when appropriate, add our own comments. We will also post events, like seminars, conferences and trade shows, that we believe will advance our readers’ grasp of China law and business.
It has become a blog cliché to implore readers for their input, but it is so important we must join the crowd on this. We do not purport to know everything about Chinese law. That is impossible. China is anything but monolithic and the differences in the legal situations between the various regions are no less pronounced than the cultural differences.
Our strengths are in forming companies in China, in drafting international contracts with Chinese companies (in English and in Chinese), in intellectual property protection, and in litigation. We welcome your comments, suggestions, and ideas on any area of law relating to conducting business in China.
In plain language, we ask that you write us early and often. We will review your comments before we post them, but that does NOT mean you should not criticize us or disagree with us. Our review will be to filter out “comment spam” and comments that are without substance and/or are personally abusive. We want to encourage a high level of discussion but we will not ban or delete your comments just because you come after us — at least not the first few times.
So why are we doing this? The short answer to this initial question is that we are doing this to — in our own small way — advance the dialogue regarding Chinese law and business.
China’s labor laws allow employers to set a probation period for an employee to see if the employee works out for the company. Before the probation period ends, if the employer can prove that the employee does not meet its recruitment requirements, the employer can unilaterally terminate the employee without having to pay statutory severance. However, to prevent the employer from abusing such probation periods, Chinese law makes clear that the employer may set only one probation period for the same employee and it imposes a limitation on how long the probation may be. The rule on the maximum length of the probation period is not very complicated and can be found here. Nonetheless, if you don’t set it right, things can get complicated and messy fast and you may find yourself at risk. We have reviewed many offer letters and employment contracts that provide for a term of probation period that does not comply with China’s employee probation laws.
As noted before, the employer is permitted to unilaterally terminate employees that do not satisfy the conditions of employment during the probation period without having to pay severance. Now consider this: an employer sets a probation period longer than the statutory maximum, and before the term of probation period ends (but after the statutory maximum period has passed), it decides to terminate the employee on because the employee failed to meet the conditions of employment. Can the employer legally do that? Probably not, because the remaining probation period is no longer considered a probation period under China’s labor laws, and the employee is thus no longer on probation and this specific ground for termination no longer exists. Can the employer still terminate the employee? It depends on the circumstances AND on the jurisdiction. Among other things, it depends on whether a permissible ground exists that justifies the termination and if the employer is able to prove it.
Another big issue is compensation. Suppose that the employer sets a probation period longer than the statutory maximum and the employment contract provides a basic salary during the probation period and a higher salary after that period. The employee continues to work after he or she has completed the probation period. Because the probation period in the employment contract does not comply with China’s employee probation laws, the employer will owe the employee the wage difference for the period between the statutory maximum and the probation period specified in the contract. In addition, the employer could also face an administrative penalty from the labor authorities.
If your specified probation period is longer than the statutory maximum, your company may also be at risk when it seeks to extend this period. For starters, even where the agreed-upon probation period is within the legal limit, the extension of such probation period may be illegal in your location. Furthermore, you may be exposing your company to additional risks if you extend a probation period that already violates the law.
And oh, just because the employee is on probation (and you don’t know if the employee is going to work out) does not mean you can wait until the employee passes the evaluation/performance review to enter into a written employment contract with him or her. For more on the importance of having a current written employment contract, see here.
Bottom line: Make sure your employment contracts comply Chinese law and it is better to do this before it is executed rather than after. All of the examples we gave above were based on China employment matters I handled, usually in a crisis, and usually at a cost way more than we would have charged had the company sought our employment law assistance at the very beginning.
Interesting article in today’s Wall Street Journal by Mark Magnier, entitled, How China Is Changing Its Manufacturing Strategy. The article deals with how China cost increases are slowly eroding its low end manufacturing base and how the Chinese government is seeking to replace that with higher end manufacturing. Not much new with this, but the article does a terrific job explaining how this is happening and even not happening in China, including with the following numbers:
- “China doesn’t release data on factory closings or relocations. But according to an analysis by researcher Justina Yung of Hong Kong Polytechnic University for the Federation of Hong Kong Industries trade group, the number of factories owned by Hong Kong companies in the Pearl River Delta near Hong Kong fell by a third to 32,000 in 2013 from a 2006 peak. Many of those that left moved to lower-wage countries.”
- “Labor costs in China have grown faster than consumer inflation for years, according to consultancy BMI Research, and are currently nearly four times those in Bangladesh, Laos, Cambodia and Myanmar.”
The article also notes how “China has managed to hold on to low-end industry far longer than its Asian neighbors at a similar stage of development,” thanks in large part to “government incentives, subsidies, the large domestic market and good infrastructure that encourage companies to remain onshore.”
The article also discusses how China’s slow move away from low-end manufacturing is costing jobs and it ends with the following quote from a Sina Weibo user: “Low-end manufacturing goes to Southeast Asia while high-end industries go back to North America and Europe. We migrant workers can’t find jobs.”
With graphs, the article shows how some of China’s apparel and shoe manufacturing has moved elsewhere in Asia, but again, not that much.
Our China lawyers have been seeing the following:
- Many manufacturing companies in China have always been owned by companies out of Taiwan and Hong Kong.
- We are getting far fewer new clients going to China to have their apparel, shoes or rubber ducky type toys manufactured in China.
- We are getting far more new clients going to China to have far more sophisticated products manufactured in China.
- A much higher percentage of the sophisticated China manufacturers seem to be owned by Hong Kong and Taiwan companies than was the case with the apparel and shoe companies of years past. This is particularly true of the (mostly Shenzhen) Chinese companies involved in manufacturing internet of things products.
What we China lawyer geeks find so fascinating about these shifts in China manufacturing is how much they have complicated the legal and IP issues both on the high and on the low end. On the high end, we have to deal with complicated quality issues and issues revolving around who owns what when it comes to the IP. When manufacturing socks, IP is not that big a deal and certainly not terribly complicated. But when manufacturing a product with hundreds of components that has been jointly developed (or at least refined for manufacturing) by both the Chinese manufacturer and our client, the IP issues can seem nearly infinite. For more on this, check out China and The Internet of Things: Who Owns What?
But surprisingly enough, we are also finding that low end manufacturing is getting more complicated as well. Take socks as the example. Ten years ago, we drafted a relatively simple manufacturing agreement between our client and the Chinese manufacturer and that was that. That agreement would make clear that the Chinese company and its factory were not to manufacture or sell the same socks to anyone else and that the quality had to meet XYZ standards and if it didn’t, then ____ would happen. But now what we are seeing a lot more often is that even a sock manufacturing deal with a Chinese company will involve a Vietnamese subsidiary that might make some of the socks. So with whom do we draft the agreement? Just the Chinese company? Just the Vietnamese company? Or both? And if both, what law applies? You get the picture, right?
What are you seeing out there?
In part one, Negotiating With Chinese Companies: Be The Rabbit, I talked about using the Zen technique of “being the rabbit,” which in Western terms translates mostly into just being patient, hanging back and letting the Chinese side start negotiating with itself. In response to that post, I received the following email from a China business consultant I greatly respect who has been in China for at least twenty years:
I liked the post on negotiating with Chinese companies. I found the best trick is to lay out terms and when the Chinese side balks, be super polite and say when you can agree to these terms please, email, call or text me. Then give them your card and leave. I always tell people the mentality of bargaining in China is the same whether buying fruit on the street, clothing in a market or doing mega deals in the boardroom. A lot of people act like they are dealing with a Japanese company. They are not. You have to have a walking away point in place before you start so that you don’t lose your cool.
Most of the negotiating techniques we are seeing Chinese technology companies employ are similar to those we have seen Chinese companies employ for decades. A classic example of an old tactic Chinese technology companies seem to constantly employ is to “lure” in Western companies to do a deal by promising the moon and then backing down from nearly every promise with each new contract draft. The best response to this tactic is usually a simple statement that you will not agree to the change and then to wait. In other words, be patient and be prepared to walk.
We are also seeing massive Chinese technology companies agreeing to a do deals with Western companies and then at some subsequent point in the negotiations substituting in some other “related” company as the signatory for the contract instead of the massive Chinese technology company. The company substituted in for the massive company is usually a brand new company created just for this one deal. When we explain that our client wants to do the deal with the massive and well-funded company and not the newly created one, we get pushback and excuses.
The Chinese technology company will claim that it “needs” to do it this way for IPO purposes or for investor purposes or because it will be able to move quicker this way. They will sometimes mouth platitudes about how “it doesn’t matter because the big company will be behind it all anyway,” but when we ask them to have the big company give its own guarantees on the deal, the big company balks. The only way to handle this sort of company switch is to be patient and to be willing to walk.
Do not fall prey to the negotiating tactics discussed above.
The post Negotiating With Chinese Companies: Walk, Don’t Look Back appeared first on China Law Blog.
As we keep saying here on the blog, Chinese companies in the last year or so have taken to trying to buy U.S. technology via just about any means possible. And as that has been occurring, we have been detailing how risky this can be for foreign companies with the technology Chinese companies want. Our previous blog posts have mostly explained the legal issues and traps these foreign companies so often find or put themselves. See Manufacturing in China: Do Not Be “Assimilated”, China and The Internet of Things and How to Destroy Your Own Company, and Selling Or Licensing Your Technology or Your Technology Business to China: Buckle Up For Some Seriously Tough Negotiating.
In response to our posts — both via comments and via emails –we have been getting requests that we explain how exactly foreign companies should respond to Chinese negotiating tactics. This post is part 1 of what will be a multi-part series on how to negotiate with Chinese companies on technology deals — or really, any sort of deal. This part 1 is not so much geared to provide strategies, but to change mindsets.
The first thing you need to realize if you are going to be negotiating with Chinese companies (technology or otherwise) is that you need to stop bargaining like a Westerner and to fully recognize that your Chinese counterpart sure as heck is not going to bargain in any way approaching what you view as fair. And if you can’t deal with that, you will pay the price.
Or as my friend Andrew Hupert likes to put it, you are the cow and no one “buys the cow when they can get the milk for free. In China, technology, IP and business methodology is the milk of profitable transactions. If you’re giving it away too early or too cheaply, then you are the expensive cow no one buys. Sorry.”
Many years ago, I had a very smart Westerner for a client who was very much into Zen Buddhism. With him we were negotiating a really tough deal with a Chinese company and every time the Chinese company would stall or push too hard or lie or agree to nine out of ten things one day and then three out of the same ten things the next day (all very common negotiating techniques of Chinese companies), my client’s response would be, “we will be the rabbit.”
According to this client, “being the rabbit” was a Zen concept of fighting back by not fighting at all, like a rabbit that goes limp when attacked by an eagle. So when the Chinese company would come back with massive changes from the day before, my client would send the Chinese company a really nice email saying something like, “I completely understand your new position and we will be reviewing it and responding when appropriate.” And then he would do nothing. Zero. Nada. Instead, he would just wait weeks and weeks until the Chinese company would come back and accuse him of having delayed this deal that needed to close so quickly. At that point, my client would say something like, I understand why you are in such a rush but we are not so if you can think of any way we might be able to speed this up, please let me know. The Chinese company would get so frustrated that it would start negotiating against itself and once it had reached the end of the line on that, my client would start negotiating again. I got the sense the Chinese company was simply not used to a Western company displaying Zen-like patience and it clearly was both irritating them and throwing them way off their game.
“Be the rabbit” is one tool among many that Western companies can employ when negotiating with Chinese companies. We will be providing more tools as this series continues.
Because of this blog, our China lawyers get a fairly steady stream of China law questions from readers, mostly via emails but occasionally via blog comments as well. If we were to conduct research on all the questions we get asked and then comprehensively answer them, we would become overwhelmed. So what we usually do is provide a super fast general answer and, when it is easy to do so, a link or two to a blog post that may provide some additional guidance. We figure we might as well post some of these on here as well. On Fridays, like today.
Today’s question comes from a reader who sent me a link to a Wall Street Journal article, entitled,
China’s Tech Rules Make It Hard for U.S. Firms to Take Control along with the following core question/comment:
You are always talking on your blog about how foreign companies are better going it alone in China and not entering into joint ventures and not entering into VIE contract arrangements. Do you think HP, Microsoft, Qualcomm and Cisco don’t know any better?
I think HP, Microsoft, Qualcomm and Cisco know exactly what they are doing and we have never said that foreign companies should never enter joint ventures with Chinese companies. My sense/guess is that HP, Microsoft, Qualcomm and Cisco have conducted thorough cost-benefit reviews of these deals and determined the rewards outweigh the risks. Our position on joint ventures are something to be wary of and to be avoided if possible. But we fully realize that there are times where the best way (and even sometimes the only way) forward in China is via a joint venture or some other sort of tied-in relationship with a Chinese entity.
The post Quick Question Friday, China Law Answers, Part XXIV appeared first on China Law Blog.
Selling Or Licensing Your Technology or Your Technology Business to China: Buckle Up For Some Seriously Tough Negotiating
If you have been reading the business news on China, two things ought to have jumped out at you. One, Chinese companies are looking to buy technology innovation. And, two, Chinese companies have a very annoying habit of backing out of their deals. For a news piece on the former, I give you this May 31 Wall Street Journal article: China’s Xiaomi to Buy 1,500 Patents From Microsoft, subtitled, “deal reflects smartphone maker’s efforts to acquire the intellectual property it needs to broaden its reach.” For the later, I give you this June 1 Wall Street Journal article: China’s Latest Export: Broken Deals.
For the last year or so, our China lawyers have been seeing the same thing. On both counts.
Let’s talk about innovation first. Can China innovate? That question has been asked countless times in the last ten or so years and this blog and our China attorneys have asked that question many times as well. Some of us have even been on seminar panels discussing that issue. But I have stopped asking that question ever since a friend of mine pointed out to me that it is no longer the salient innovation question to be asking about China. I his view (and mine now), the better question is a slightly broader one. The better question is whether China can secure innovation either by generating its own or by buying it. Truth be told, many in China, including at the highest levels of the government, have given up on China becoming a top-tier innovator and have therefore turned their attention to China becoming a top tier innovation acquirer. Add in the fears of a declining Yuan and you have all you need for a golden age (or period anyway) of China innovation acquisitions. And that is exactly what is happening and exactly what our China team has been seeing. Chinese companies are looking to acquire innovation/technology/IP any way they can, including by licensing, by purchasing (either the technology itself or the entire company) or by joint ventures.
Now let’s talk about why so many of these technology deals do not come to fruition and that naturally will lead us to why negotiating these deals is so incredibly difficult and why we subtitled this post “Buckle Up For Some Seriously Tough Negotiating.” The Chinese government is telling Chinese companies to acquire technologies and Chinese companies badly want to acquire technologies, but this does not mean they are not having a really really difficult time securing those technologies the way a company from, let’s say Spain or Germany, might go about acquiring such technologies.
Here is how our firm did a technology licensing deal for a Spanish company recently. This Spanish company wanted to buy a U.S. company with a cutting edge technology. The Spanish company spoke with the U.S. company and they negotiated a purchase price and generally discussed other key terms. The Spanish company then did its due diligence on the U.S. company and that due diligence uncovered a few warts and raised a few issues. So the Spanish and the American company sat down again and negotiated on some of the new issues and renegotiated on some of the old issues, and within a week or so the deal was again ready to move forward. The whole process from start to finish took 3-4 months.
Here is what typically happens when we represent an American company seeking to do a technology deal with a Chinese company:
- The American company and the Chinese company reach what sounds like a perfectly reasonable deal.
- We draft up the perfectly reasonable deal and the Chinese company then completely changes it.
- Our American company tells the Chinese company that it cannot do the new deal the Chinese company has just proposed.
- The Chinese company comes up with some really bizarre explanation for why the new deal it is proposing is absolutely essential and explains why the deal our client thought it had can never work.
- We then spend weeks explaining why the old deal is just fine, while the Chinese company alternately acts like it will do the old deal with just a few small changes or hints very strongly to our client that it should take the new deal or the Chinese company will just walk away.
I could go on and on, but you get the point. The point is that Chinese companies like to draw in American and European companies with what looks like a really good deal and then go back on that deal. Chinese companies negotiate like this because they realize that once an American company commits to a deal, it wants to close the deal. Once five people in an American company have told their fellow employees that “we have a deal with XYZ Chinese company,” those five employees do not want to have to keep negotiating that deal for another 5-6 months or just walk away from it. Chinese companies know all this and they seek to wear down the other side, plain and simple.
Chinese companies will change the deal not just monetarily, but in even bigger ways as well. Have a deal where you don’t turn over anything about your technology unless and until you get a large upfront payment? Prepare for an explanation from the Chinese company weeks into the deal why that is no longer possible. Have a deal where the Chinese company is supposed to get your three year old technology? Prepare for an explanation months into the deal as to why you now need to replace that with your newest technology, and all at the same price. Again, I could go on and on.
So how should an American or a European company handle this sort of negotiating. By remaining firm and resolute. Not kidding. In subsequent posts, we will go into greater depth on how to negotiate with Chinese companies. So stay tuned….