By Dan Harris
International Manufacturing Turmoil Increases International Manufacturing Risks
With all the turmoil created by the tariffs and the various other increasing risks of manufacturing in China our international manufacturing lawyers are being contacted by many companies seeking legal help after all has been lost. These are mostly companies that moved their manufacturing to “bad” Chinese manufacturers or to other countries in an effort to reduce their costs or to avoid tariffs and duties. Nearly all of these companies failed to appreciate the risks of starting with a new manufacturer or were simply unwilling/unable to do the things necessary to ameliorate those risks.
The Two Most Common and Deadly International Manufacturing Mistakes
I will start by explaining the two most common and oftentimes deadliest mistakes our international manufacturing and IP lawyers have been seeing of late — in just about every country you can imagine, ranging from Poland and the Ukraine in Europe to Vietnam and Thailand in Asia to Mexico and Colombia in Latin America. I will then set out the rules you must follow to survive when starting up your manufacturing with a new overseas manufacturer, wherever in the world that manufacturer might be.
1. The “Lose Your Product Trap”
Probably the worst trap we see is what I will call the “lose your product trap.” Under this scenario, Foreign Company A takes its design or its not yet realized product to Overseas Manufacturer B and asks if that manufacturer can make it. Overseas Manufacturer B says “yes but it will need a whole host of modifications and we can help with that”. A product is eventually fully developed and at that point Foreign Company A asks Overseas Manufacturer B how much it will cost to have the product made. The manufacturer then quotes a price 2-5 times higher than anything anyone else is charging and Foreign Company A then calls one of our international manufacturing lawyers for help.
The problem at this point is that Overseas Manufacturer B has planned has probably already filed a utility patent or a design patent on the product and is already selling it around the world and only expensive litigation in multiple countries has any chance of stopping this and even that is not likely to succeed. Foreign Company A often believe this whole thing is just a cultural or linguistic misunderstanding and our lawyers can use their international experience to convince the overseas manufacturer to sign a reasonable contract. Sadly, this almost is never true and our best advice is usually that the foreign company should move its manufacturing to some new country where Foreign Company A does not have a patent. Much of the time, the foreign company simply cannot afford this, after having just spent so much with its original overseas manufacturer.
2. The Lose Your Trademark Trap
The other common trap we see is when Overseas Manufacturer A register’s Foreign Company B’s brand name as Overseas Manufacturer A’s own trademark in the manufacturing country. Overseas Manufacturer A has usually filed for this trademark within a few days of its first initial contact with Foreign Company B and once registration of that trademark is complete Foreign Company B will use its leverage to double or triple its prices, knowing that Foreign Company B cannot use anyone else in that country to make its products with its brand name on them without infringing on Overseas Manufacturer A’s trademark. Overseas Manufacturer A is thinking that if it gets the newly doubled or tripled price it will continue to manufacture for Foreign Company B and if it doesn’t get that price, it will start manufacturing Foreign Company B’s product under Foreign Company B’s trademark and sell it around the world itself. In other words, Overseas Manufacturer A cannot lose.
Why do Companies Allow Fall Into These Traps?
After they’ve fallen prey to the above problems, companies often tell our lawyers that they never knew these sorts of things went on outside China or that they could do anything to protect themselves against them. This last explanation is exactly what we would hear 15 or so years ago about China, but eventually most companies realized there were things they could do to protect themselves. Many companies also tell us is that they chose not to pay for any protections because they knew XYZ country has such a terrible legal system and so there could be no protections. Wrong, wrong, wrong.
Let’s take trademarks as an example and let’s imagine we are dealing with whatever country has THE most inefficient, least developed, most corrupt legal system in all the world. If you secure a trademark for your brand name in that country — which is a relatively easy and inexpensive thing to do pretty much everywhere in the world — and you secure a trademark for your brand name in every country in which you have more than minimal sales of your product, you have effectively blocked anyone from being able to stop you from using your brand name in those countries in which you have a trademark. See Do You Manufacture in China? Let’s Talk United States and Canada and Mexico and EU Trademarks. Does this stop someone THE worst country from using your trademark? Probably not. But it does stop them from being able to shut you down for using their trademark that they secured on your brand name. I realize this is complicated but it is super important and so I suggest you read this paragraph again and then read China Trademarks: Register Yours BEFORE You Do ANYTHING Else and apply this in any country in which you will be manufacturing.
China Factories Have Become Riskier
With foreign buyers fleeing China, our China lawyers are seeing an increase in Chinese factories playing tricks on their existing customers. China has in the last year lost approximately three million manufacturing jobs and with China factory revenues have plunged as well. Chinese factories are scared and desperate and they are seeking short term money because they do not believe their foreign customers will be with them for the long term. Chinese factories that are operating at a loss or believe they soon will be when their customers leave for Vietnam or Mexico or Thailand are dangerous. These factories are increasingly cutting corners on quality and taking their foreign buyer’s IP and competing with them. See Your China Factory as your Toughest Competitor and Chinese Suppliers: Competitors not Friends.
In China Trademark Theft. It’s Baaaaaack in a Big Way, we discussed the recent increase in trademark thefts:
But starting about a year or so ago, our China trademark lawyers started getting a ton of China trademark theft calls, and the number of those calls has been accelerating ever since. Why has the tide on trademark “theft” come in again? Two reasons. One, there is hardly a soul in China who does not know how to get around the prohibition on an agent registering the trademark that rightfully should go to the foreign company for whom it is acting as an agent. If your manufacturer in Shenzhen wants to secure “your” trademark in China it will not go off and register it under its name, as it knows that cannot work. So instead of registering the trademark under its own Shenzhen company name, it will ask a cousin or a nephew in Xi’an to register it under its company name, making it nearly impossible for you to invalidate the trademark. Two, many (most) Chinese factories are hurting and they desperately want to improve their profit margins. What better way to do so than to sell a product under a prestigious or well-known American brand name — or even just any American brand name? See Your China Factory as your Toughest Competitor.
In China Factory Disputes: The 101, we wrote about product quality and other Chinese factory problems:
Many China factories are in deep trouble due to declining sales stemming from the US-China Cold War. I base this not just on the economic statistics everyone is seeing but also on the fact that our China lawyers are getting a steady stream of emails from foreign companies reporting the usual range of problems whenever China’s factories start suffering.
Our international manufacturing lawyers have been getting a ton of emails from foreign buyers that are being pursued by their Chinese factories for refusing to pay for defective products. Typically the foreign company is trying to achieve some sort of compromise while the Chinese factory is insisting on full payment.
There are a lot of huge risks for foreign companies in these situations, and the typical first question we ask a company in this situation is how easily can they just up and move their manufacturing outside China. If they say they can, then we start working with them to achieve that as quickly as possible. If they cannot, we start talking about the sorts of defenses they need to start building.
With all the China problems these days, one of the easiest things you can do to avoid or resolve a China factory dispute is to move your manufacturing out of China. See Moving Your Manufacturing Out of China: The Initial Decisions and How to Move Your Manufacturing from China AND Protect Your IP. The risks of manufacturing in China are even higher if you are in a dispute with your Chinese factory. See Has Sourcing Product From China Become TOO Risky? But those risks are also typically at their highest at the beginning of any new relationship with a factory, whether that factory is in China or in Thailand, Mexico, Vietnam or wherever.
How to Avoid Overseas Manufacturing Problems
The best way to reduce the likelihood of having problems with overseas product suppliers is to recognize that most overseas manufacturing problems stem from something the product buyer failed to do to prevent the problem or reduce its damage. In other words, it is up to you to reduce your risks. See China Factory Problems: Always YOUR Fault?:
The title is somewhat of a stab at humor. It stems from my blaming most (but certainly not all) China factory problems on the foreign buyer. We have written countless times of what is required to secure good product from Chinese factories.
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We have also written how our China lawyers constantly get calls or emails from American and European companies that have received bad product from their Chinese factory suppliers and how there is nothing we can do for them. We wrote about this just last week in How To Get Bad Product From China With No Legal Recourse. To a certain extent, we like being able to blame the victim in these situations because that way we as lawyers can comfortably sit back and tell ourselves that had they only contacted us BEFORE they started having problems, we could have prevented all of their problems.
Everything written above about China holds true almost everywhere outside China, as well.
But what exactly should you do to protect yourself when manufacturing overseas? The below six basic things are key.
- Use a Good Manufacturer. If you do nothing else that we suggest in this post, do this one thing because it matters as much as all the other factors put together. If you do not know how to find a good manufacturer, pay for someone who does. At the very minimum, make sure the company you will be using to make your products actually exists and is licensed to engage in the business for which you will be paying it. If you cannot afford to do these things, you should not be manufacturing overseas. Not kidding.
- Use Good Manufacturing Agreements. Good contracts ensure that your overseas manufacturer knows what is required of it and what will happen to it if it does not meet those requirements. For what constitutes a good Overseas Manufacturing Agreements go here. For what constitutes a good overseas Mold Protection/Mold Ownership Agreement, go here. For what constitutes a good overseas NNN Agreement, go here. For what constitutes a good overseas Product Development Agreement, go here. Well over 90 percent of the overseas manufacturing contracts we see are worthless because they are usually written by someone who either does not know manufacturing or does not know international law, or both. Many are worse than using no contract at all. See Why Your NDA is WORSE Than Nothing for China. And yet I cannot tell you how many times a company has come to us with a major problem and said that we had our domestic lawyer write this or that contract for us and so we know it might “have issues” and we have had to tell them that their only possible remedy is against that lawyer.
- Use Detailed Documents. Overseas factories that engage in contract manufacturing tend to do exactly what you tell them to do. This means you need to clearly convey what it is that you want them to do, and that means your instructions and specifications should be detailed and in their language. See China OEM Agreements. Why Ours Are In Chinese. Flat Out. Be overly specific.
- Visit the Factory. Either your own people or a third party QC company should pay regular visits to your factory. Doing this allows you to make sure your factory understands what you want and lets them know that you are serious about making sure you get it. It also humanizes you and tells them that you really do care and are not just putting things down on paper to look good to your own buyers or to abide by some regulation somewhere. Trust me when I say that this one should not be underrated.
- Inspect Your Products. Perform regular product inspections appropriate to the product you are having made.
- Register Your IP. If you have IP worth protecting (and pretty much all of you do), make sure you do everything you can within reason to protect it wherever you are manufacturing your products and wherever you sell your products. This means trademarks, patents and/or copyrights.