How to protect IP when buying from and manufacturing in China (Feat. Dan Harris of China Law Blog)

Dan Harris, Partner of the US law firm Harris Sliwoski LLP and long-time writer of the China Law Blog, shares his tips on common IP risks in China and steps you can take to protect your business when you buy from Chinese suppliers or manufacture your products there.

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What are the major risks to IP concerning working with Chinese companies that Western businesses should look out for?

The risks are different for Western manufacturing and technology companies.

Manufacturers – The top risk is having their Chinese manufacturer legally sell their branded product for less than it costs for them to have it made. This can kill a business, and it is legal for the Chinese company to do it if the Western buyer has not taken the necessary legal steps to prevent it from happening.
Technology companies – The Chinese company may incorporate their technology into their own products, subsequently selling the product as a competitor. huawei has been accused of this by many Western companies it used to supply. Technology can often be harder to protect than a brand name or product. (03:27)

Western companies consistently underestimate the risks of their technology and IP being used against them.

Some Western companies license their technology to a Chinese company for big money. The Chinese company usually wants to split the payments by year, for example, paying US$10 million over 10 years. In response, the Western company agrees to drip-feed the technology each year, not granting the Chinese business full access immediately. The risk here is that the Chinese company cancels the deal with the Western supplier as it has gained enough technological know-how after, say, 5 or 6 years for its own staff to take the next steps to build products that, while not being equal in terms of technological advances, are similar enough that they can dominate in markets like Pakistan, Guatemala, and other emerging regions where price is more important than using cutting-edge products. Then in a few more years, they may move ahead under their own steam, leaving former licensors in their wake.

The scale at which the Chinese can do things also has an impact on speed. ‘China speed’ and ‘Shenzhen speed’ are real terms, and there are stories of Western hardware startups approaching potential suppliers in China with some designs, and seeing their unique new product on the market within just 6 weeks. Needless to say, this can kill a hardware startup that perhaps has not even been able to launch their product yet, and even if they have or will, can’t compete on price with the Chinese copycat version which is probably being sold at their production cost (and it may be somewhat rougher or simpler, but that doesn’t stop the damage from having been done). (07:58)

Has the Chinese legal system evolved for the better (or worse) regarding IP protection?

The legal system improved year-on-year between 2000-2013, after which it has only slightly improved. If a business does things ‘correctly,’ China’s legal system is OK at protecting IP. For example, suppose you have registered your trademark in China and a local company copies it. In that case, you can sue them and win pretty easily (unless your product type is one the government has a great interest in such as advanced semiconductors).

However, the IP risk landscape in China overall for Western companies doing business and having products made there is in an extremely bad place right now, because IP theft tends to increase when the economy in China is struggling. Therefore, these days when the economy is at a low ebb, IP risks are very high as companies struggling to stay afloat there may look for any opportunity to improve their situations. Add in the context of American (and to a somewhat lesser degree European) companies trying to leave China ASAP, and the Chinese suppliers now view these as short-term relationships which gives them even more incentive to misuse IP for their own gain. (13:39)

Protection 1: The right partner.

There are 3 key ways to safeguard your IP: The right partner, the right contract, and the right protections.

Good manufacturers in China do not steal IP. This is too large a risk for their business, as other customers will flee as soon as it becomes known, and they’re in demand because they have that good reputation that’s worth upholding. Many Western companies get into trouble because they did not do their due diligence and end up working with an untrustworthy manufacturer. So a great way to reduce your risks is to do your sourcing well and get expert help to find a suitable manufacturer there if needed. (20:11)

Protection 2: The right contract.

Before you show any designs or other sensitive IP to Chinese suppliers (or those from any location in fact), you need them to sign a contract that is enforceable in their country that clearly states that they can’t use what you show them to compete with you or reveal it to others. Beware of using an American-style NDA, for example. This will not be effective in China and is worse than no NDA in some ways.

Getting a legitimate supplier (who you have already taken pains to source) to sign a Chinese NNN agreement will prevent IP theft in 99% of cases because that sort of company does not want to get sued. (28:11)

3. The right protections.

If you intend to brand products, trademark your brand name in the product’s category in China as this will prevent other businesses from using your brand on their products. Importantly, this should be done even if you are only manufacturing the product in China and not selling in their domestic market, as it will give you the ability to go after companies who use your brand and to get their copycat products stopped at the border and blocked from export.

Some companies who do not even manufacture or sell their products in China go as far as to register a Chinese trademark, as this gives them an amount of global protection as counterfeiting tends to come from China. Instead of registering multiple trademarks for the countries you sell in (that are arguably less likely to counterfeit the products), the couple of thousand dollars or so cost of only registering in China that can protect against counterfeits reaching any of your markets can be very good value.

Registering a Chinese trademark is a no-brainer for most businesses that manufacture products. Not only is it cheaper than an NNN agreement, but the agreement only protects you against the one company that signs it, whereas a Chinese trademark protects against 1.3 billion people, all of whom cannot use it once it is registered.

If you are purchasing products from a Chinese manufacturer, say heavy equipment, this is not about IP protection so you don’t need an NNN agreement or trademark. As a buyer, you need to be sure that the supplier is trustworthy and legitimate before you send them a payment, so a due diligence report on the business is most important. (30:21)

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