The increased quality of Chinese manufacturing and the attractive cost savings realized in moving U.S. operations to China make outsourcing to China an option that many U.S. companies have undertaken or are considering. Such outsourcing relationships often require the sharing of valuable intellectual property rights with Chinese counterparts creating a potentially risky situation if the U.S. company does not carefully consider the peculiarities of doing business in China and the Chinese legal system. This article provides a brief overview of the considerations that U.S. companies establishing outsourcing relationships in China should bear in mind with regard to protecting their intellectual property rights.
While risks to the integrity of a company's intellectual property rights exist in any outsourcing arrangement, taking steps to understand the intellectual property system in China, carefully selecting local suppliers, clearly documenting the expectations of each party, and actively monitoring the use of one's intellectual property can assist in mitigating the risks to a company's intellectual property when outsourcing to China.
INITIAL STEPS: REGISTER
Prior to beginning discussions with potential Chinese partners, U.S. companies should identify the intellectual property rights that are potentially involved in its China plans and consider registering this intellectual property both in the U.S. (if not registered already) and in China. While China's legal mechanism for protecting intellectual property rights is in place, it is still developing. However, without intellectual property registration protection in China, traditional legal remedies are not available if there is future infringement. As a primarily "first to register system," it is also imperative that intellectual property be registered in China as soon as possible to protect a company's rights and to have access to legal avenues of recourse. Concerns about the cost and time involved in registering intellectual property in China or concerns about confidentiality should be carefully weighed against the potential value of accessing the Chinese judicial system if necessary to address infringement.
In addition to registration of a U.S. company's intellectual property rights, it is important that any license agreement to use a company's intellectual property rights be recorded in China. Such recordation creates a clear public record of a company's ownership in the licensed intellectual property, and with regard to trademark rights in particular, such recordation confirms that the goodwill associated with the trademarks flows to and benefits the U.S. company as the owner of the marks (and not the licensee).
DUE DILIGENCE
After initiating efforts to register its intellectual property rights in China (or after careful consideration of such registration) but prior to negotiating a contract, a company should carefully evaluate several potential partners. The extent of such due diligence will clearly depend on the type of product being manufactured, the type of intellectual property involved and the length of the proposed relationship. However, key considerations in carrying out due diligence with a potential Chinese partner include: (i) a review of the potential partner's financial information and business license; (ii) information about other outsourcing relationships that the Chinese company has established and references from such partners (preferably including a description of the Chinese company's handling and protection of the intellectual property of others), (iii) what processes and systems are in place to protect intellectual property rights; and (iv) location of the factory, including whether it is located in an area known for protecting intellectual property (China is highly regionalized and consideration should be given to the local reputation and attitudes toward the protection of intellectual property when choosing a partner).
Many consultants exist in China that can help companies find and evaluate potential Chinese partners. After an appropriate partner is chosen, then the contracting period is the time to begin defining and building the outsourcing relationship.
CONTRACT NEGOTIATION
It is important that the parameters of one's relationship in China be carefully detailed in a written contract. Chinese companies will generally abide by written contracts but the contract language should be as specific as possible and avoid terms of art that might be ambiguous or open to interpretation. If a contract is considered punitive or does not make economic sense from the perspective of the Chinese partner, it is less likely to be enforceable. As a result, contracting parties should strive to be fair. In addition, if a clause in a signed contract goes against Chinese laws or regulations, such clause will be considered void and will have no effect making more imperative the need to also have appropriate counsel review the contract. U.S. companies should make every attempt to document all aspects of the relationship from the onset of the contract. It should also be noted that a contract is often thought of by Chinese parties as subject to change as the relationship between the contracting parties develops.
With regard to intellectual property, any agreement should include all standard intellectual property protection clauses, i.e., ownership, use, protection and confidential information. Provisions should be included to require consent for all subcontracting arrangements, use of excess inventory, waste or substandard product (a particularly important issue since infringing products may quite literally be coming from the back door of the factory) and promotional use of business products or brands. In addition, audit rights should be included so that companies can monitor production and take steps to confirm compliance with the contract. In addition, key employees should execute separate contracts covering the protection of intellectual property. ONGOING CONCERNS
After the contract is signed, U.S. companies should maintain and develop the relationship with their Chinese partners, establish industry appropriate ways to protect intellectual property (such as by taking anti-counterfeiting measures including limiting the supply of certain key components), and perform regular audits. If the relationship ends, the U.S. company should be careful that intellectual property is protected and that steps are taken to insure key information or products are destroyed, including monitoring of the market and visiting the Chinese factory, if possible.
Cozen O'Connor's intellectual property and other business attorneys work regularly with local counsel in China to guide clients through the registration process, to explain the regulatory environment (and how it affects the ability to contract with regard to intellectual property rights) and to assist with ongoing audit and compliance monitoring so that those U.S. companies outsourcing to China can achieve the strongest protection possible with regard to their intellectual property. For more information, please contact Camille M. Miller (Philadelphia) at 215.665.7273 or cmiller@cozen.com or David M. Albert (Philadelphia) at 215.665.7277 or dalbert@cozen.com.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.