China NNN Agreements: What to do When Negotiations Bog Down

The below is an email from one of our China lawyers to a client explaining why our client needs to stay firm in its position regarding its proposed NNN Agreement. This email involves an initial NNN regarding a product the Chinese company wanted to review to help it determine whether it wanted to buy stock from our client to make a large stake investment in our client. This email is from quite some time ago on a deal that has already concluded. It has been modified slightly so as to camouflage any possible identifiers.

I reviewed the NNN agreement we provided you and I reiterate that there is no basis to make changes to what we drafted for this deal.

There are three provisions of the NNN Agreement that restrict the Chinese company’s right to make your product for themselves or for other entities.These provisions provide that the recipient (Chinese Company) shall not:

— Make any commercial use of Confidential Information in competition with you.

— Sell any Product or goods similar to the Product which make use of your Confidential Information to anyone other than you.

— Use any Confidential Information provided by you in any manner to create any goods for any entity other than for you.

These provisions only apply to the improper use of your confidential information and there is no way any party acting in good faith could interpret these provisions to provide for any restriction on their right to manufacture and sell their own products or to manufacture and sell products designed by some other entity. Since the Chinese manufacturer’s concern is without basis and makes no logical or legal sense, there is no revision that should be made.

Note also that we have used these “offending provisions” hundreds of times in China (and their predecessor provisions hundreds of times as well). In the early days, some Chinese factories expressed concerns with these provisions and so we carefully revised them to deal with those concerns.

If ___________ [China manufacturer] continues objecting to this clear and restricted language you should assume you have a problem. The only way ____________ [China manufacturer] could have a problem with this language is if it believes the Confidential Information is not unique and has already been provided to them by one of your competitors and is not owned by you. This is one reason Chinese entities object to an NNN agreement: they do not believe what you will provide them is unique or owned by your company.

When this specific objection is raised and we think the objection has merit, we add a provision stating that if the Receiving Party proves the Confidential Information was previously disclosed to them by a third party and if the Receiving Party proves it is currently making use of the Confidential Information in current production for itself or for a third party, the provisions of the NNN will not apply. However, it would be a mistake to add this language to the current NNN agreement because this type of objection is never made regarding companies in your situation and because __________ [China manufacturer] is not making this specific objection and there is no reason to suggest such an objection is conceivable with respect to your Confidential Information. This kind of “you don’t really own the information” objection is raised only in the case of new designs from bare startups where the design is not patented or trademarked and where the product has no history of having been manufactured or sold. No one would consider raising this objection to mature products from a mature company such as yours. But that is not what _____________ [China manufacturer] indicates as their current concern. They say their concern is that the quoted language will prevent them from manufacturing and selling to __________ [a competitor]. The simple answer is that this language does not mean that and no one reading the actual written terms in good faith would read them that way, and prior to this, nobody ever has.

As we have discussed, given that you are dealing here with a direct competitor, you do not want to allow for any ambiguity at all. You have a 100% right in all Confidential Information and _____________ [China manufacturer] is not permitted to make any use of the Confidential Information in any way that competes with you. It’s pretty simple. They either agree or they don’t. When a Chinese company raises these kinds of meritless objections, all you should say is: “Sign it or we will not go any further with our discussions.” And that is exactly what you should  do here. Any company raises this kind of objection regarding clear and unambiguous language will be hard to deal with in working on a full scale sale stock agreement.

Note that when we draft a final Stock Sale Agreement, we will include transaction specific confidentiality provisions that will involve additional customized language not included in the current NNN. For now, however, the most important issue is to test out ______ [China manufacturer]. Will it act reasonably or will it continue to make arguments that make no legal or business sense? It will be good for you to know this right away.

As always, please feel free to contact me if you have any additional questions.

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.