NDA — No Way for China

The first step in doing OEM manufacturing in China is to find a good factory to make the product. For entrepreneurs who want to protect their newly designed product from infringement, this is a dangerous stage. Almost all foreigners make a major mistake at this stage. Their mistake is that they try to protect themselves with an NDA (a nondisclosure agreement) rather than with a China enforceable NNN (non-use, non-disclosure, non-circumvention) agreement.

I will consider what is required for a good NNN agreement in a later post. For now, I want to show why an NDA agreement is what you do not want. I have reviewed hundreds of NDA agreements used in China. Not one of them has been of any use to the foreign party. Not one. Why is that? Why would so many good IP lawyers draft agreements that are of no use to their clients?

The reason is technical, so stick with me, because understanding the technical legal issue will provide the key to figuring out what you really need to do. An NDA agreement is focused on protecting trade secrets. Trade secrets are a form of intellectual property, just like trademarks, patents and copyrights. The essence of a trade secret is simple: in order to be protectable property, the information must remain a secret. If the “secret” is revealed to the public, there is no more protectable property.

For this reason, NDA agreements are focused on preventing disclosure of the secret to the public. That is the sole issue. Once disclosure occurs for any reason, there is no more property right in the information and any associated NDA agreement is not valid. Good NDA agreements are therefore narrowly focused on control of the secret information and in preventing that secret information from being revealed to the public.

Most lawyers in the U.S. and Europe are working to maintain their domestic intellectual property portfolio. Trade secrets are created by law and these lawyers are therefore concerned with ensuring protection of the trade secrets in their portfolio. For this reason, it is natural for an American lawyer to draft a single NDA agreement that is subject to U.S. law, written in the English language and exclusively enforceable in some U.S. state.

Though I understand the reason for this kind of drafting, it is critical to understand that this kind of NDA is of absolutely no value in China. There are two reasons for this:

1. The fundamental issue in China is not protection from disclosure to the general public. To be blunt: the Chinese factory that steals your idea is not planning to disclose that concept to the general public. The factory that steals your idea is planning to use it for its own benefit. Therefore, what is required is a contract that prevents the factory from infringing. The prohibition must be based on the contract, not on the status of the concept being a secret. That is, the foreign party must say: it does not matter whether the information I provide to you (the Chinese factory) is a secret or not. By contract, you (the Chinese factory) are agreeing not to use the information in competition with me. If you consider what is really required, this will show you why reading the typical NDA is a strange experience, because the language appears to be far removed from the actual situation. So what is needed in fact is an NNN, as I will explain in my next post.

2. The other fundamental problem with the typical European or U.S. style NDA is that the agreement is not enforceable in China. Chinese law allows for protection of trade secrets. Chinese law also allows for contracts that provide for complete NNN protections. However, for such a contract to be effectively enforceable in China the contract must be governed by Chinese law, must be governed by the Chinese language and must be exclusively enforceable in a Chinese court. We have explained in detail why this is true in earlier posts and I will not repeat myself here.

This is not a trivial matter. I meet often with North American and European entrepreneurs working to manufacture new and innovative products in China. I ask: have you already given away your idea to the Chinese side? The common response is: no, I have not, because I used an NDA drafted by my U.S. intellectual property lawyer. In 100% of those cases, I review the NDA and then have to explain that their NDA is useless.

The result is that in virtually all of these situations, the entrepreneur has already given away their critical ideas and there is nothing that can be done. They are now subject to the good will of the Chinese side, which is an unpleasant situation. This is very distressing news for young inventors dreaming of becoming the next Apple or Cisco. Imagine the meeting with the investment bank who is doing their IPO when the letter arrives stating that the Chinese factory claims ownership of the product.

The solution is simple: do it right from the start:

1. For the typical manufacturing setting, use an NNN agreement that is enforceable in China.

2. If you really have a trade secret to protect, use a separate NDA agreement focusing solely on the trade secrecy issue that complies with the requirements of Chinese trade secrecy law (yes, there is a formal statute) and is enforceable in a Chinese court.

Take the NDA you have been using and throw it away. Then remember the basic rule: in China, you have to start out right. Correcting your mistakes later does not work.

The post NDA — No Way for China appeared first on China Law Blog.

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.