China and The Internet of Things and How to Destroy Your Own Company

Many years ago, I spoke at a major technology event about how to protect your IP from China. I rarely use notes when I give a speech, which leads me to oftentimes riff on various things. At some point during that speech, I mentioned how technology companies were our dumbest clients when it comes to China and I went on to explain why. I talked of how the ethos of tech companies is to focus on building things (be it software or hardware or whatever) as quickly as possible, and not to worry about much else. I talked of how tech companies (in an effort to save money) are reluctant to hire good management, choosing instead to put their money into the core of their business — their tech people.

I then talked about how I completely understood all of this, including how this modus operandi no doubt does make sense when operating purely domestically. But I then when on to explain why it is such a disaster for China, where it is usually impossible to “fill in” a legal foundation later. After my talk, the questions asked of me and the comments made to me made clear that though around a third of the audience wholeheartedly agreed with this assessment of mine, two thirds were moderately to very unhappy with them.

Well for what it is worth, I will no longer describe technology companies as a whole as our dumbest clients when it comes to China. No, that honor now clearly belongs to a subset of technology companies: Internet of Things companies. And mind you, we love, love, love Internet of Things companies. For proof of this, just go to our recent post, China and the Internet of Things: A Love Story. Internet of Things (a/k/a IoT) companies are sprouting all over the place and they are booming. Most importantly for us, they need a ton of legal work because just about all IoT products are being made in China, more particularly, in Shenzhen.

So then why am I saying they are so dumb about China? Because they are relinquishing their intellectual property to Chinese companies more often, more wantonly, and more destructively than companies in any other industry I (or any of my firm’s other Chinese lawyers) have ever seen. Ever. And by a stunningly wide wide margin.

In describing IoT companies and their problems to others, I use the following as my prime example, taken from at least a half dozen real life examples in just the last few months:

IoT Company: We just completed our Kickstarter (sometimes Indiegogo) campaign and we totally killed it and so now we are ready to get serious about protecting our IP in China.

One of our China Lawyers:t Great. Where are you right now with China?

IoT Company: We have been working with a great company in Shenzhen. Together we are working on wrapping up the product and it should be ready in a few months.

China Lawyer: Okay. Do you have any sort of agreement yet with this Chinese company regarding your IP or even costs or anything else.

IoT Company: No. All we have is an MOU (Memorandum of Understanding). They’ve really been great. They have told us that they would enter into a contract with us whenever we are ready.

China Lawyer: Can you please send us the MOU?

IoT Company: Sure.

China Lawyer: Okay, we will look at that and then get back to you with our thoughts.

Then, a day or two later we a conversation like the following ensues:

China Lawyer: We looked at your “MOU” and we have bad news for you. We think there is a very good chance a Chinese court would view that MOU as a contract. (For why we say this, check out Beware Of Being Burned By The China MOU/LOI) And the Chinese language portion of the MOU — which is all that a Chinese court will be considering — is quite different than the English language portion. The Chinese language portion says that any IP the two of you develop (the IoT company and the Chinese manufacturer) belongs to the Chinese company. So what we see is that as things now stand, there is a very good chance that the Chinese company owns your IP. This being the case, there is no point in our writing a Product Development Agreement that your Chinese manufacturer is not going to sign.

IoT Company: (And I swear we get this sort of response at least 90 percent of the time) I’m not worried. I think you have it wrong. I’m sure that they will sign such an agreement because we orally agreed on this before we even started the project.

China Lawyer: That’s fine, but I still think it makes sense for you to at least make sure that they will sign a new contract making clear that all of the IP associated with your product belongs to you, because if they won’t, there is no point in our drafting such a contract and, most importantly, there is no point in your paying us to do so.

 So far not a single such IoT company has been able to come back to us with an agreement from their Chinese manufacturer to sign.

We have lately been getting a slight variation on this theme, where the IoT company is farther along in its product development and is actually now at the point of selling its product. This newer situation is exemplified by the email below, which is an amalgamation of various emails received, all fairly recently, and with any and all kinds of modifiers to make it impossible for anyone to be able to guess the companies:

Here is my situation. I am hoping your firm can help us figure out the best course of action going forward. [Then usually follows a description of their company and their IoT product and how they ended up going with a particular Chinese manufacturer and why they failed to seek out the advice of a China lawyer until now. BTW, this description far too often involves their domestic attorney having told them that he or she would turn them over to a “China specialist” as soon as that “becomes necessary.”]

We do not have any contracts in place with our current manufacturer. We started the relationship with our current manufacturer a year ago. He told us that POs are contracts in China and our lawyer here confirmed that. We sent him our design, paid for the molds, and he shipped us the products. Recently, we found out that he used our product pictures as marketing material on Alibaba. We suspect he is selling our products all over the world. A week or so later, I found out that he has filed for a design patent for our design in China.

We just started the working relationship with [online retailer]. Our manufacturer doesn’t know that. All I told him is that we are working with a big client, and if he doesn’t sign any agreements with us at this point, we’re not going to place new orders. He then told me he’s willing to sign a non-disclosure agreement with us. But based on what he has done, I don’t think it is in his best interest to work with us in the long run.

We’re filing design patents in the US. If we continue to work with him during this period, which agreement would help us get the best protection?

Since he already claimed our designs in China, will that prevent us from working with a new manufacturer?

Do you advise we work with a new manufacturer at this point?

Our response has been something like the following:

A PO is not really a contract it is the placing of one order. Unless your PO speaks to IP (which would be very unusual), it almost certainly will not help us here. On top of this, some Chinese courts do not see POs as a contract at all and some Chinese courts will not even look at a document that is not in Chinese. The ideal is a Chinese language contract sealed by the Chinese company.

Our biggest concern is that this manufacture has gone off and filed for a design patent for your product. This will no doubt pose problems for you and for any new Chinese manufacturer you might seek to use. Depending on how far along your present manufacturer is in the patent process, it may be able to sue you and your Chinese manufacturer for damages and to force production to cease. At minimum, he will be able to cause you all sorts of problems unless you can stop or invalidate his design patent. At this point, there is a good chance that this Chinese manufacturer literally owns your product in China and he can use that ownership to control what you do there.

If you seek to go to a new manufacturer you can be sure of two things: one, your old manufacturer will NOT give you the molds you think you paid for and two, it will use its design patent to, at minimum, block your products from leaving China. It also very well may sue you for patent infringement in a Chinese court. In the meantime, making your product in China will be an extremely high risk proposition.

Based on the information you have provided us, it appears that you have four options, none of which are terribly good:

1. You leave China entirely and you start manufacturing in some other country. Is this possible?
2. You seek to block or invalidate your existing manufacturer’s design patent. This will not be accomplished quickly or inexpensively.
3. You try to strike some sort of deal with your manufacturer whereby it assigns the patents to you and in return you agree to keep using it for manufacturing for x number of years. It may agree to this if what you can pay it will exceed what it can make by selling your product on its own. The fact that it has offered to sign a non disclosure agreement does not mean much at all, since such an agreement will not help you and your manufacturer almost certainly knows this. For why this is the case, check out Why Your NDA Does Not Work for China. You need him to sign a contract that actually makes clear what IP belongs to you and makes clear his limitations in using your IP. At this point, it sounds like you need a China-centric OEM Agreement.
4. You go to a new manufacturer in China. If you do this, you almost certainly will not have your molds and there is a good chance your existing manufacturer will make a lot of trouble for you by suing or threatening the new manufacturer, etc.

IoT companies (and everyone else too): Don’t let the above happen to you. For more on how you can prevent this, go read China NNN Agreements and China Product Development Agreements.

NOW!

The post China and The Internet of Things and How to Destroy Your Own Company 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.