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China Product Development Contracts: I Don’t Get No Respect
Saturday, January 10, 2015 10:28
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When someone emails one of our China lawyers asking us what they need to protect themselves when manufacturing in China, we typically respond with something like the following:
Our clients that manufacture product in China typically use us for some or all of the following:
NNN/NDA Agreements. We do these NNN Agreements in Chinese (the official version) and in English (for you). These typically take us 4-5 business days to complete. You can learn more about our NNN Agreements here and here. These NNN Agreements aim to protect the confidentiality of your product and to prevent your Chinese manufacturer from competing with you or circumventing you. They make sense before you have chosen your Chinese manufacturer. The logistics of these are that we first send you via DocuSign.com a one page Flat Fee Agreement setting out the fee structure. Next we send you a questionnaire and then we draft the NNN in English for your approval. Once you approve, one of our China lawyers translates it into Chinese and we send that to you. You then send it to your Chinese counterpart and if they propose any changes (which happens about 50% of the time with them just approving it around 50% of the time) we revise it until completion.
OEM Agreements. Once you have chosen your Chinese manufacturer, you need an OEM Agreement (these are sometimes known as manufacturing agreements or product supply agreements). You can find out more about our OEM Agreements here, here, here, and here. These typically take us 10-14 days to complete. The process is pretty much the same as for the NNN Agreements. If you are already certain who you will be using as your Chinese manufacturer you can skip the NNN Agreement and go straight to the OEM Agreement as our OEM Agreements contain all of the substantive provisions of our NNN Agreements.
China Trademarks. If you plan to put your company or brand name on your products or on their packaging you will also want to register your brand name and/or your product names and logos as trademark(s) in China. As we discuss here, this is true even if you will not be selling your product in China.
There is one more contract that is occasionally needed and that is a Product Development Agreement. A Product Development Agreement makes sense for those foreign companies that do not have a finished product ready for manufacturing and will be working with a Chinese manufacturer to develop the new product. These agreements cover the cost and procedure for developing a product. Many companies fail to enter into this kind of agreement only to discover later that the Chinese side owns “their” product IP or the molds or the tooling at the end of the process.
In our experience, a Product Development Agreement is needed well under five percent of the time. This being the case, we do not mention it in our initial email setting out what is “typically” needed for having a product manufactured in China. I estimate that an NNN Agreement is needed around 50% of the time (the other 50% of the time there is nothing worth protecting or the secret has already been revealed and therefore the other benefits of an NNN Agreement will go into the OEM Agreement. I estimate that an OEM Agreement is needed 99.9% of the time and a trademark registration about 98% of the time.
Anyway, the problem that we as lawyers face is that when a Product Development Agreement is needed, it is almost always needed in addition to everything we mentioned in our email and our clients and potential clients by that point have reached what should probably be best described as document fatigue. I mean, who knew that something as simple as getting a widget made in China would require four separate legal line items. This makes our clients/potential clients reluctant to sign up for that “just one more document.” Think Monty Python’s thin mint.
We recently had this situation with a good client and the below is the email (modified slightly to remove any identifiers) one of our China lawyers wrote to this client on the pros and the cons of our doing a China Product Development Contract for this client (called ABC Company):
As discussed, the basic problem with having a Chinese (or Taiwanese) factory do product development without a development agreement is ownership of the IP should ABC Company not end up ordering products from the factory. We talked about what happens if the factory cannot make the product pursuant to your specifications. The variant of this that we see most often is when the factory likes the product and thinks it can do better selling it on its own, and once development is complete, it quotes the buyer (in this case, that’s you) a ridiculously high per-unit price. The buyer says forget it, at which point the factory thanks the buyer for reinvigorating its product line. We have seen this scenario play out dozens of times, and the buyer has absolutely no recourse: it has no agreement covering development, and it did not pay the factory a dime. I don’t think there’s a court in China that would hold the factory accountable.That being said, I am not unsympathetic to your concerns. A separate development agreement would increase the cost of the process, and it would take additional time – time that you may not have, if your target launch date is mid-2015. I can’t say how your factories would respond, but sophisticated factories are (or should be) familiar with such an agreement.Your point about your ongoing relationship with Chinese Manufacturer A and Chinese Manufacturer B providing some comfort is also well taken. The sort of behavior I describe above is more likely to happen with a factory that has no previous relationship with the buyer, and therefore more incentive to opt for a “sure thing” short-term gain. And it doesn’t happen every time. But we would be remiss as lawyers, and in particular as professionals with years of experience dealing with Chinese factories, if we didn’t flag the loss of your IP as a significant risk here. And the best way to protect against loss of your IP is to have a separate development agreement.If you don’t want to do a separate development agreement, the next best option is an OEM agreement with two essential features. First, you will want a paragraph stating that the factory will be doing product development for Company ABC but that Company ABC will own all of the IP. This may not be enforceable, but it is better than nothing, and it will at least memorialize the parties’ understanding. Second, you will need language about mold ownership, and you absolutely must pay for the molds.Do not let the factory create the molds for free. If you do not pay for the molds your arguments that you own the molds will hold little to no weight.Given Company ABC’s time and cost constraints, and the primacy of product design (and hence molds) to the new product line, a single OEM agreement for each factory seems to be the most realistic course of action.Don’t hesitate to contact me should you have any questions about the above.
China Product Development Contracts: They Don’t Get No Respect.
We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you 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.
Source: http://www.chinalawblog.com/2015/01/china-product-development-contracts-i-dont-get-no-respect.html
