Outsourcing in China: Five Basics for Reducing Risk

?by: Steve Dickinson

Many small and medium sized companies that engage in OEM manufacturing/outsourcing in China fail to take the steps necessary to protect themselves. When problems arise, they can do little or nothing to protect themselves because they have no legal basis for protection. The fact is that outsourcing disputes must be resolved in China, under the Chinese legal system. The Chinese legal system has improved greatly over the past ten years and taking a few basic legal steps can greatly reduce your risk. The cost of such protection is modest compared to the protection it will provide.

The following five basic steps will greatly reduce your problems with Chinese manufacturers, while improving your chances of recovering should any problems arise.

1. Create and properly register your intellectual property rights in the United States. If you do not have a firm basis for your IP rights under U.S. law, you will have nothing to protect in China. Before you go to China, be sure your intellectual property is protected under U.S. law. Protect your brand identity by creating and registering your trademark, slogan and logo with the U.S. Patent and Trademark Office. Register your important copyrights with the U.S. Copyright Office. Carefully identify and protect your trade secrets, proprietary information and know how.

2. Register your trademarks in China. Registration can protect your future access to the Chinese market, prevent the export of counterfeit goods from China, and prevent a competitor from registering your mark in China, which would prohibit you from exporting your own product from China.

3. Use a written agreement to protect your know how and trade secrets in China. Small and medium companies usually do not have an extensive portfolio of patents. Their most valuable intangible assets typically are their know how and trade secrets, which cannot be protected by formal registration. Chinese law, however, permits companies to contractually protect their know how and trade secrets by contract. Such agreements may also address issues such as non-competition and confidentiality. Without such a written agreement, no such protection is available.

4. Product Quality and Payment Terms. The rule here is simple. Do not make final payment to your Chinese manufacturer until you are confident you will be getting an on time shipment of the correct items and quantities at the quality standards you require. This usually means you must incur inspection costs in China and provide for a clear procedure for dealing with these problems as they arise. You must take the lead on this. You cannot depend on the OEM manufacturer to do this for you.

5. Use comprehensive OEM Agreements with each manufacturer. Small and medium sized businesses often enter into OEM manufacturing transactions with a simple purchase order. This is a mistake. The purchase order will protect the Chinese manufacturer, not you. Your protection depends on your securing a written OEM manufacturing agreement with each Chinese manufacturer with which you deal. The ideal OEM agreement will address all of the issues discussed above while also addressing other basic legal issues such as jurisdiction and dispute resolution. This agreement should be in both Chinese and English, since the Chinese language version will control in China.