Moving Your Manufacturing Out of China: Do You Really Own Your Product?

Our international manufacturing lawyers have been working with a ton of companies that are looking to pull their manufacturing from China and move it elsewhere, to places like Mexico, Colombia, India, Vietnam, Thailand, etc. One of the first questions we ask when providing legal counsel regarding such moves is who owns the IP related to the product. Far too often our client does not know and sometimes even after we lawyers look into this issue, the answer remains unclear.

We then have to explain to our client that moving their manufacturing from their existing Chinese manufacturer to any other manufacturer anywhere in the world (including within China) could open them up to lawsuits. Oftentimes we are able to resolve this problem by getting the Chinese manufacturer to sign a contract agreeing that our client is the sole owner of the IP, but this is nearly impossible to do if our client has already told their Chinese manufacturer that they are leaving China. See How to Leave China and Survive.

How did we get to this point where the IP rights of a product are so often vague? The process has worked its way through the following three general stages:

Stage One. In the good old days (roughly 1981 to 1995), the situation was simple. There were two possibilities. In the first, the Chinese manufacturer made a standard consumer product. The foreign buyer purchased that existing product and perhaps required the Chinese manufacturer take the extra step of placing the buyer’s own trademark/logo on the product. In that setting, ownership of the intellectual property was clear: the Chinese manufacturer owned the product design and the foreign buyer owned its trademark/logo. In the second, the product was a long standing, well developed product of the foreign buyer. The foreign buyer brought the completed product to the Chinese manufacturer and contracted with the Chinese manufacturer to make a copy. In this setting, ownership of the intellectual property was clear: the foreign buyer owned all the intellectual property and the Chinese manufacturer owned nothing.

The simplicity of this sort of relationship encouraged the somewhat lazy practice of documenting the entire manufacturing relationship with purchase orders. Since IP ownership was clear, even the most basic IP protection agreements, such as an NNN agreement, were seldom used.

Stage Two. In stage two (roughly 1995 to 2015), a new form of manufacturer-buyer relationship developed. Foreign buyers began coming to China with no completed project in mind; they instead would come with a product idea or proposal. The foreign buyer would then work with the manufacturer to co-develop a product. In some cases the Chinese manufacturer would simply take a completed prototype and commercialize that prototype for mass production. In these cases, the foreign buyer arrived with little more than a basic idea and the two sides worked to co-develop the product. See China Product Development Agreements for pretty much everything you need to know about China product development agreements.

The Chinese manufacturer usually would perform the product development work at its own expense, with the implied agreement that it would be the exclusive manufacturer of the product. This approach then led to the many issues we see today that make answering the “who owns what IP” question so difficult. To do the co-development process properly, the parties must define their relationship with three agreements: 1) an NNN Agreement, 2) a Product Development Agreement and 3) a Manufacturing Agreement.

When these agreements do not exist, a standard set of issues arises: Who owns the product design? Who owns the molds and other tooling? Who owns the manufacturing know-how and similar trade secrets? If the buyer decides to have the product made by a different factory in China or outside China, what compensation is owed to the Chinese manufacturer that co-developed the product? What are the  Chinese manufacturer’s obligations to comply with the foreign buyer’s price and quantity requirements? If the Chinese manufacturer terminates its relationship with the foreign buyer and manufacturers the product under its own trademark/logo, is this a violation of any agreement between the parties? Absent clear written agreements, none of these questions have clear answers. In these unclear situations, the Chinese factory will nearly always be in a much stronger position than the foreign buyer and the Chinese factory will typically prevail in any IP dispute.

Stage Three. In stage three (2015 to today), we arrive at the smart product era. In designing, developing and manufacturing smart products, the already unclear and problem-filled relationships of the stage two era are now magnified. In the stage two era, there was at least the simplicity of two entities designing and/or manufacturing a single product. In the smart product era, the situation is considerably more complex. In most of the smart product projects our lawyers have handled, the development process has expanded to include the following:

1. Product “concept” from the foreign (usually United States or European) buyer.
2. Product external design, from an international design firm.
3. Internal design and function.
4. Design of the smart product “app” (usually for smart phones).

The Design of the smart product app involves two completely separate sets of software: the communication sending software residing on the physical product and the communication receiving software residing in the application. In the same manner as the internal design, these software components may be written/designed by multiple parties: the foreign buyer, the Chinese manufacturer and (quite often) third party software design firms.

What happens then when the product is complete, and manufacturing is ready to start and the foreign buyer starts to seek funding: The funding source almost invariably will ask who owns the smart product and who owns its underlying IP? What our China lawyers have far too often found when we ask the foreign buyers these questions is that they usually don’t really know.

This “we don’t know” response does not sit well with potential sources of serious financing. Even worse, when the foreign buyer is pushed to answer the question, it becomes clear that it is not clear who owns the new product. Far too often the only ownership issue that is clear is that the foreign buyer is the one entity that does NOT own the rights to the product. Even worse, it is usually not possible to fix the situation by this point. This “we don’t know response” also does not sit well if you are looking to move your manufacturing from China.

Two Takeaways: One, do not even think about moving your manufacturing from your existing Chinese manufacturer until you clear up whether you actually own what you are seeking to move. Two, before you sign anything with your new manufacturer (in whatever country that might be), get clear on who will own what and make sure you have an enforceable contract reflecting that.