Unlike some blogs that pretend to talk about “China Law”, when they are really talking about how to get around Chinese laws, I decided to talk about how Chinese people need to protect themselves in international businesses.

This is Post #1.

First, I’m an ethnic Chinese (7/8 Han, 1/8 unknown).  I’m trained and qualified as a US attorney, but I’m not qualified in Chinese law.  So most of what I will talk about is on US laws.  My discussions are for general legal education purposes, not for specific legal advice on specific individual cases.  If you need specific legal advice for your situations, please consult qualified attorneys in the relevant jurisdictions.  If you need to find a qualified attorney, feel free to post your request in the comment, and someone may be able to refer a good lawyer to you.  I’m not soliciting any clients here.

The reason I wanted to start this post as a continuing series, is that recently I am very dismayed to find many cases where I believe Chinese companies and individuals have been thoroughly abused and taken advantage of, because they simply did not prepare themselves adequately in the legal issues.

Most Chinese I know do not want to think about laws.  They believe themselves to be honest and law-abiding, and thus assume themselves to be safe from harm in any legal systems.  Yet, unfortunately, in the practical world, that assumption is naive and won’t stop unscrupulous people from taking advantage of legal loopholes and trickery to harm Chinese people.

Most honest Chinese people would probably prefer to conduct their business on hand-shakes and verbal promises, but most Chinese people today would agree that such is not possible.  Yet when it comes to contracts, I have seen too many Chinese businesses and individuals who do not review contracts carefully, nor even consult lawyers to do so.

For example, I have bumped into cases, where US businesses soliciting investments from Chinese people, promising them ridiculous unrealistic rate of return, but ONLY in the Chinese version of the contract, and then put in all kinds of legal disclaimers for potential losses and downside in the English version of the contract (which is ultimately the only version signed by both parties).

I understand that some Chinese businesses like to take risks, but taking risk with the law is never a good idea, because as they say in America, “You can’t fight city hall,” you will lose every time.

At the same time, US laws are getting tougher, and reaching further into China.  Chinese people are no longer immune to the reaches of US laws, even from within China.  But at the same time, Westerners are generally immune from the reaches of Chinese law, unless they put themselves in China.

This rather unbalanced relationship puts Chinese people and businesses in an inherent disadvantage in the world, even in China.  Thus, Chinese people and businesses need to take laws, even US laws, more seriously, in their business dealings.

Today’s topic:  Intellectual Property in Contracts

1 most popular way for US laws to reach Chinese people these days relates to IP, such as copyrights, patents, trade secrets, etc.  And this is also 1 area where Chinese businesses can easily get into trouble in business dealings.  Particularly because often time, it’s difficult to know where the IP is.  I.e. what is patented, what is copyrighted, and what is trade secret.

When a Chinese businessman talks to a US businessman, does the Chinese businessman know what IP “landmines” he might walking into??  What’s to say that the US business won’t sue the Chinese party for “trade secret theft” tomorrow, if the business deal goes sour??

Increasingly, in the last few years, US government (and other Western governments) in the name of protecting IP, have rapidly expanded the coverage definition of their IP laws.  Particularly, in “trade secret” laws, US has mutated the century old laws originally designed to protect only products and manufacturing recipes, into laws that protects pretty much all forms of confidential business information, and has even expanded the “Economic Espionage Act” to cover these mutated “trade secrets”.

So, bottom line, if a Chinese businessman talks to a US businessman, any “confidential information” that the US side gives may be interpreted as “trade secret” under US law.  And if tomorrow, your business relationship sours, that US business might just decide to sue you in US for “trade secret theft.”  So, now do you feel comfortable talking business with US??

What do you do?  For starters, a Chinese businessman should walk into the 1st meeting with a “Non-disclosure Agreement” /NDA of his own, and make the US side sign it.  The NDA should preferably include clauses in English, stating that “information, documents, codes, software, recipe, drawings, confidential or otherwise, disclosed by US party via any agents, shall not be considered trade secret, unless the US party obtains written agreement from the Chinese party, that the information, documents, codes, software, recipe, drawings are trade secrets, PRIOR to the disclosure.”

In plain English, that means, if the US side wants to claim something as “trade secret”, they have to get the Chinese side to agree that the information is “trade secret” before disclosing it.  Otherwise, every thing disclosed is non-trade secret.

Another issue, copyrights.

Many documents are copyrighted, even if not specifically registered as copyrighted.  Contracts cannot nullify copyrights.  But contracts or NDA’s should indicate that unless specifically reserved or licensed, all documents, codes, software disclosed by the US party via any agents, have their copyrights licensed NON-exclusively for unlimited uses by the Chinese side.”  This would prevent the US party from claiming (such as in the recent AMSC v. Sinovel case) that the US side never licensed the software /etc. to the Chinese party.

In plain English, that means, if the US side turns over some code to Chinese party without specifying it in the contracts, the code is automatically licensed.

A big issue now is when a US party’s employee decides to steal US party’s information and give/sell to Chinese party.  In such a case, the Chinese party is often accused of “conspiracy” or bribery to steal “trade secrets”, even if the Chinese side may be guilty of no more than offering to hire a competitor’s employee (which happens all the time in Silicon Valley).

What to do?

(1) If the Chinese party and the US party has a business relationship, the Chinese party should include in its contracts with the US party that, beyond the above suggested clauses, “the US party shall indemnify the Chinese party for any costs/damages arisen from civil and/or criminal liabilities caused wholly or in part by the conducts of any employees or former employees of the US party.”

In other words, if the US party’s employee caused some problems, the US party has to pay for the Chinese party’s legal fees.

(2) if the Chinese party and the US party has no business relationship, the Chinese party should preferably consider reviewing the US party’s employee’s employment contracts and NDA’s to determine the risks.  What if the US party’s employee just discloses a bunch of confidential information about the US party??  (a) first option is to NOT use the confidential information at all, that sort of “spy out of the cold” is very risky, (b) other options are all pretty risky, so I won’t even mention them.

Leveraging your Chinese position

Some Chinese businesses may see my comments above and say, “Will US side actually sign?  Why would they?  What if they just refuse?”

I say to my fellow Chinese, you have more leverage than you think you do, and you should have more confidence about your position in China.

Foreign businesses want to go to China and expand.  The market lure is undeniable, even if so many of them are now complaining about how hard it is in China.

Why?  It is Greed and Corruption.

Greed is just for the possible amount of money to be made in China.

Corruption is that honestly, many foreign businesses want to expand abroad to hide their corruptions.  (Same reason why so many rich Americans, even their politicians, have accounts in the Cayman Islands).  It’s not JUST the money, it’s that they want to hide possible illegal immoral sources of income.

China is no different in that respect to many foreign businesses, on multiple levels.

(1) China is a lower tax jurisdiction for many foreign businesses, particularly the ones that make things.  Why does Apple want to make things in China?  Not just because Chinese labors are cheap, but because their profits generated in China are taxed lower than in US.

In this, many foreign businesses do very “creative accounting” to make their domestic profits look lower than they actually are.  How?  Even when they say they are generating IP in their home countries, they rarely want to attribute their Chinese profits as really from their domestic IP’s, such as software, etc..

Some of these accounting are technically legal, but some are very dubious.

So if a foreign business want to bargain over terms, Chinese parties should consider leveraging the tax laws of US and China, as the reason why the foreign businesses need to come clean, OR why they should understand that Chinese party will not take the risk of being sued later, when the foreign parties are enjoying the tax breaks early on.

(2) Some trade are legal for China, but illegal for foreign nations.

Specifically, “export control” laws in US place a lot of technologies as restricted, and do not allow export of such technologies to China, directly or via another country.

Even if some technologies could be legally exported, many foreign businesses do not want to go through the trouble of “export control review”.

Technically, Exporting party often bear the responsibility to conduct export control review clearance.  But, if “export control” is violated in a business deal, the Chinese party receiving the restricted technology may be found guilty of “conspiracy” to violate export control, even if the Chinese party had no knowledge of the “export control” restriction.  The consequence of this is very serious.  The Chinese party may be permanently or temporarily barred from many business deals requiring export/import.

Thus, it is extremely important for the Chinese party to require the foreign party to clear “export control” reviews for EVERY possible piece of technology in their business deals.  You cannot contract your way around this rule, because the foreign party may not sue you over this, but the foreign government may bar you from ever doing business in export/import with their countries.  (Unfortunately, these types of laws are applied unequally, and usually much harsher on the Chinese companies than foreign companies like BAE or United Technologies).

Also, because the risk is so high, the Chinese party should always consider using a subsidiary or intermediary to do the actual export/import, so to shield the parent corporation from direct criminal liability.

Since the risk to the Chinese companies are high in this respect, the Chinese party should leverage the risk as a bargaining chip in business dealings, i.e. requiring the foreign companies to compensate the Chinese parties for the risks and any resulting damages.

Otherwise, the foreign companies have the lower risks, obtain the benefits of potentially illegal transactions, while the Chinese parties get the higher risks, more harsh punishment in foreign nations.  That’s simply a bad deal.

Above all, the Chinese party should not voluntarily “help” the foreign parties in “export/import”.  Any such “help” may be interpreted as part of a conspiracy.  Let the foreign companies clear the customs on both side by themselves.  They are not that stupid.

(3) other advantages in China.

They may not say it openly, but they are in China for some specific reason.  They don’t fly 1000’s miles for an ordinary business deal with just some profit margins.

For one, it’s actually very easy to set up a business in China.  That’s attractive to foreign businesses looking to make some quick money in a large market like in China.

But that carries the inherent risk that the foreign business deals may go sour quickly.

It’s like a hot and fast romance that can end very badly.

So, before a quick wedding, slow down and consider a big “prenuptial agreement”, mark your possessions before the deal, and agree on how to split up if the deal goes bad.  I.e. an “exit/dissolution strategy” should always be in the contract.

i.e. avoid long term deals that you can’t possibly promise.  In AMSC and Sinovel, Sinovel agreed to contract for multiple years of buying parts from AMSC, even though Sinovel was 80% of AMSC’s market.  That was a very optimistic but bad idea.  Sinovel ultimately got stuck with dissatisfaction with AMSC’s services, and tried to end the shipments, but that caused a nasty contract dispute that still goes on today.

Realize that the foreign companies have very little cost to start making and selling in China, there is no reason to give them the additional benefit of having a long term contract.  Instead, give them at most “year-to-year” contracts.