Why NDAs Do Not Work for China, but NNN Agreements Do

Why NDAs Fail in China: Use an NNN Agreement Instead

A few years ago, in The Power of China-Specific NNN Agreements, I explained why China NNN Agreements are so important when doing business with China. Within a few hours of that post, one of my law firm’s China lawyers pointed out that if we are going to encourage China NNN Agreements over non-disclosure agreements (commonly referred to as an NDA), we should explain why an NNN is so much better than an NDA. This post does that.

Most lawyers tell their clients that are doing business in China that they need an NDA. Many businesses see the typical NDA as an unnecessary and unenforceable “piece of paper” they use only if their legal department forces them to do so. The normal questions I get about NDAs are the following:

1. How can I prove the information mentioned in my NDA was revealed?
2. How can I prove what was revealed was actually confidential per my NDA?
3. How can I enforce the NDA agreement even if I could prove the facts?”

Their concerns are well founded, particularly when dealing with China. In fact, most NDAs my law firm’s China lawyers see are completely useless for China because they are directed at the wrong issues, and they are unenforceable. Pulling your English language NDA and having it translated into Chinese is a complete waste of time as your resulting document will either be worthless or — more likely — worse than having nothing at all.

I feel compelled to repeat this. A Western-style NDA is worthless or worse for China; for China, you need a China NNN Agreement. When my law firm’s international manufacturing lawyers work on international manufacturing arrangements, we never just draft a “straight NDA.” Instead, we draft a “non-disclosure/non-use/non-circumvention agreement” that we refer to as an NNN Agreement.

The Three Primary “Bad Acts” an NNN Agreement Addresses

When a foreign company client contracts with a foreign/Chinese company to manufacture a product, the NNN focuses on the three primary “bad acts” the foreign company client needs to prevent.

1. Preventing Disclosure to Third Parties

The foreign company does not want its design revealed to a third party. To prevent this, a non-disclosure agreement is required. Though this is an important issue, disclosure to an unrelated third party is not common with China manufacturers.

Your bigger risk is disclosure to a related party. Many Chinese businesses have multiple subsidiaries, and they often do their manufacturing through a large network of subcontractors. Chinese companies tend to be relaxed about passing around information within this network. A good non-disclosure agreement must focus on controlling information within a network that the Chinese manufacturer itself does not consider as falling within the scope of a non-disclosure requirement.

2. Preventing the Chinese Manufacturer from Competing with You

The biggest concern of the foreign company is usually not disclosure to a third party. They are usually most concerned about preventing their Chinese manufacturer from making use of the foreign company’s own product designs to compete with the foreign company. For this, a non-use agreement is required.

A good non-compete agreement for China must focuses on two issues. First, the agreement should identify the applicable intellectual property or confidential information of the foreign company, and then authorize the Chinese manufacturer to use that intellectual property or confidential information solely to manufacture product for the foreign company.

Second, the agreement should require the Chinese manufacturer never manufacture the product or any similar product other than for the foreign company. This second provision prevents the Chinese manufacturer from manufacturing a similar product under its own trademark. Since many products are not covered by a patent, trademark, or other IP protections, the only way to prevent such “copy-cat” manufacturing is with such a non-use provision. NDAs completely fail to account for this.

3. Preventing the Chinese Manufacturer from “Circumventing” You

The foreign company also does not want its Chinese manufacturer to circumvent them by selling the foreign company’s product to the foreign company’s existing or future customers. After the Chinese manufacturer has manufactured your product for a while, it likely will have learned about the market for your product and your customers.

You do not want that manufacturer to tell your customers that they are the company actually making your product and since your product has no patent or other IP protection, suggest that they buy your product directly from them, for a lot less. This is called circumvention, and it is extremely common with Chinese manufacturers. NDAs completely ignore this.

Most non-disclosure agreements our lawyers see are the standard NDA used in the United States or Europe, and those agreements do not address the special problems of related parties in China or the need to protect against circumvention. Only a carefully thought-out NNN Agreement that resolves these issues has value for China.

But even if these NDA agreements were to account for all three of these issues, virtually all NDAs our China lawyers have seen are unenforceable in China because their non-disclosure provisions did not deal with related parties, nor do they address non-circumvention. And even the best agreements are of no use if they cannot be enforced. This is the other major defect of the NDA agreements our China lawyers see; they are simply not enforceable.

How to Make Your NNN Agreement Enforceable in China

For an NNN Agreement to be enforceable, it must be enforceable in China. To increase your chances of having an enforceable NNN Agreement, the following usually makes sense:

1. Choose the Right Venue for Enforcement

The agreement usually should provide for enforcement through litigation in a Chinese court or via Chinese arbitration. T

2. Choose the Right Official Language 

If you are going to be litigating your NNN Agreement in a Chinese court, its official language should be Chinese. Otherwise, there is a good chance the Chinese court will never hear your case, and even if it does, it will use its own translator to translate your agreement into Chinese, and those translations are rarely good for the foreign company.

3. Choose the Appropriate Liquidated Damages

Most NDA agreements rely exclusively on injunctive relief as their primary enforcement mechanism. This is a major mistake in China.

The preference for injunctive relief in common law systems (such as the United States or England) is because it is often difficult or impossible to prove the economic damages that result from a breach of the contract. This is not really an issue under Chinese law, where parties to contracts are encouraged to set a fixed amount for damages caused by a breach.

If written correctly, the liquidated damage amount sets a floor on damages, but if actual damages exceed that amount, it is permissible to seek damages for the excess. In addition, money damages and injunctive relief are not exclusive. A court or arbitrator is free to order damages be paid and that the breaching party terminate its infringing action. Lastly, China’s court procedures make seizing bank accounts relatively fast and easy up to the amount of the liquidated damages set forth in the contract.

NNN Agreements with a liquidated damages provision that complies with Chinese law make clear to your Chinese counterparty that they will be at risk if they breach your contract and, by doing this, you go a long way towards discouraging a breach. Having a properly written liquidated damages provision in your NNN Agreement also makes for quick and effective litigation/arbitration.