Various Responses Elicited by Binding NNN Contract in Chinese Context

In the last post, enforcing NNN agreements was discussed in the Chinese context. The issue raised was that the contracts having some support so that they can be beneficial to the party doing business with Chinese manufacturers. Now, properly formulating an NNN contract can reduce the chances of infringement by Chinese factories and also any kind of litigation subsequently. The reasons for the same will be discussed in the following paragraphs.

The basic reason is that the Chinese manufacturing companies are scared of their courts. They are not afraid of an order from the court stating them to behave properly. However, they are afraid of a verdict stating that a certain sum of money must be paid to the counter party or the court will seize assets and auction them for compensation. What they most afraid of is a prejudgment seizure during which the court will seize the property and retain it until the court case is settled. They are very much aware that a properly drafted NNN agreement cantered around China factory practices is powerful enough to move the court and get an order to freeze the factories’ assets. This is the last thing the factories want.

Kinds of responses against NNN Contracts

Chinese factories respond in the following 3 manners against a well drafted contract:

  • Refusing to SignThere are companies which refuse to sign any kind of agreement; they had planned to steal the trade secret right from the beginning. In fact, examples state that some companies are so aggressive and blatant about their intention that they refuse and say that they wanted to appropriate the trade secret. If they cannot do so, then they won’t continue to talk. However, this can be a blessing in disguise because accepting the intention right at the beginning can save business parties from committing a grave mistake. However, this kind of situation is rare but when happens benefits the business organization or the client.

  • Negotiation ProcessSome Chinese manufacturers will start a serious discussion on particular matters that they will not accept as part of the NNN contract. These companies take the agreement seriously and thus want certain provisions to be excluded and incorporate elements reflecting their own interest. In such cases, usually the concerns of the companies are mostly false, but in certain cases they reveal that they have a similar technology which they do not want compromised. This could be a positive sign because it will imply that the company is unreasonable and difficult to do business with. In case they already have an existing technology, the discussion will be fruitful as both the parties will be trying to protect individual technologies. The chances of establishing a proper contact is possible under such a circumstance. The foreign companies mostly used to think that the Chinese do not have a technology of their own in place, but that is not true anymore. Even they have their technologies and the foreign companies need to enter into a contract that is beneficial to both.

  • Serious ContractIn this scenario, the Chinese factory will treat the NNN contract very seriously and approach the 3 obligations with care. This does not mean that they will discard years of bad practice, but in most cases litigation for violation is not required. It is resorting to a threat of litigation against violation which will make them more careful and not step onto your foot while doing business. This is particularly helpful during circumvention.

These points explain the general approaches taken by Chinese firms towards the NNN agreements. With foreign companies, it is more like using the agreement as a threat to litigate in case of any violation. However, the contract should be able to convince them regarding their tricky situation. They are particularly afraid of a monetary litigation. Foreign companies can use it to their benefit. Remember that they are expert at seeing through bluffs, so make the contract literally binding with lot of support and corroborating facts so that they are compelled to take it seriously.

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3 Vital Elements of NNN Contract

You want to launch a new product and want to get it made at a Chinese factory. Accordingly, you find out that factory and now you are on your way to do business with them. However, doing business with a Chinese factory is not easy and we are revealing the reasons behind it in our posts. The most important aspect to worry about is protecting your idea from being stolen. An American style NDA contract will not suffice; instead you will require a China binding NNN contract.

The 3 Ns stand for:

  • Non-use
  • Non-disclosure
  • Non-circumvention

Non-use stands for not using the idea, concept or product by the Chinese factory which might hamper your business and also your reputation. They cannot compete with you by using your product or concept. This point in entirety needs to be written down in the contract so that it is binding on the Chinese company. The most critical point here is that nothing is based on abstract property rights; instead everything is based on a binding contract from where the obligation arises. Copyright, trademark, patent and intellectual property rights are not valid in Chinese context and hence it has to be a more tangible aspect. To make it more prominent, get an NNN agreement prepared for your Chinese manufacturer which will prohibit it to use your idea or product. If the Chinese company signs the contract, you are no longer required to look for other legal help.

Non-Disclosure

This is not a very important aspect in a Chinese agreement because they are not keen on exposing factory’s knowledge to the general public. Instead they are keen on using it for their own purpose and hence including this provision is not mandatory in the contract. However, if you have included the above mentioned provision in the contract, the Chinese factory will encounter a problem. To beat this problem, they will not breach the contract directly, but will disclose the idea to someone in the group which will make them safer.

Now, it is important to understand the different kinds of groups that can exist in the Chinese market. Two things must be made clear in order to do business with them. They are:

  1. Disclosure is particularly prohibited inside the group
  2. In case there is any disclosure, the company dealing with the group is fully liable for that

Majority of Chinese companies do not consider sharing information within the group as breach of contract. Under such a circumstance, you must understand the different types of groups.

  • Families run business in China and they can share information within the family members running the company.
  • Subcontractors form an important part of the company. However, they are constantly changing and hence disclosing the idea to them is basically a breach which is not considered the same by the Chinese organization.
  • Huge Chinese companies often have numerous subsidiaries owned by a parent company and members of all these companies will know the idea or know about the product.
  • In China many state owned enterprises are running business who do not consider other SOEs as separate competitors. The main problem with such organizations is that they are government aided and hence do not see any problem in sharing the useful information provided to them by foreign companies.

Finally, non-circumvention deals with profit making. The Chinese company knows that you will sell the product by hiking the price and retaining your profit margin. It is only natural and feasible for the Chinese factory to track and obtain your customer list and contact with them directly trying to sell the products made for their clients. This is a malpractice which has several side effects and China lawyers often get a call from potential clients talking about this problem. Lot of foreign companies are already on the verge of shutting down due to these malpractices.

Circumvention is dangerous and it must be prevented by hook or by crook. Only an NNN contract can prevent it and hence you must draw it to protect your company. These elements constitute the most important part of NNN agreements in China which must be drawn carefully to simplify and to protect the business from being shut. Your NNN agreement must be incorporated with some tools that will help in controlling the Chinese manufacturing companies.

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