By Dan Harris
One of the primary ways foreign companies lose their IP to China is via infringement by manufacturing or service subcontractors. Our China lawyers constantly see/hear of foreign companies that enter into “iron-clad” contracts with a primary Chinese company, only to lose their IP to a subcontractor for whose behavior the primary Chinese company has no responsibility.
Often, the subcontractor is in some way related to the primary Chinese company and the infringement is intentional. In other cases, the subcontractor has no direct relationship with the primary Chinese company and is simply trying to create a new business for itself. Either way, subcontractors are a big threat to your intellectual property and they must be treated as such.
There are essentially the following three options for dealing with subcontractors in your China contract:
1. Prohibit subcontracting. This is our preferred option but it is often not practical. You should, however, always consider how it seldom it makes sense for your primary Chinese company to need to contact subcontractors at the NNN stage, rather than later at the product development or manufacturing stage. A China manufacturer (or service provider) that is claiming it must deal with its subcontractors at the NNN stage is oftentimes a Chinese manufacturer planning to steal your intellectual property. Some of the larger electronics and Internet of Things (IoT) hardware manufacturers are notorious for this.
2: Permit subcontractors, but make your primary Chinese contractor liable for the subcontractors’ conduct. This is the standard option to which most Chinese manufacturers and other Chinese companies will agree, simply because it is the easiest system to manage. In the last ten years, virtually no legitimate Chinese manufacturer or other Chinese company has objected to this option in the NNN stage for the reason discussed above: no subcontractors are usually involved at the NNN stage.
3: Limit the use of subcontractors. We often draft contracts that limit the Chinese company to using subcontractors only when the following conditions are met: a) the primary Chinese company gives written notice of each subcontractor, b) our foreign client formally approves the subcontractor and c) the subcontractor enters into a separate NNN contract with our client. This is actually a very good system, since it gives you a direct contractual relationship with the subcontractors who have all signed binding contracts that explicitly protect your IP. Note though that this almost never comes up at the NNN stage, only after. This requires you draft and get signed formal agreements with each subcontractor and you may have to deal with your Chinese manufacturer (or lead service provider) that is worried about you cutting them out by going direct to their subcontractors.
Even though subcontracting should not be relevant at the NNN stage, we often put a subcontracting provision in our NNN Agreements because it can force the primary Chinese company to reveal that it is not really going to be doing the manufacturing or the work, but instead will be using a subcontractor to do everything.
Dan Harris is founder of the Harris & Moure law firm, a boutique international law firm focusing on small and medium sized businesses that operate internationally. China is the fastest growing area for the firm. Dan writes ChinaLawBlog.com as a source of China legal and business information.