Outsourcing to China – Best Practices for SMEs to Avoid Scams and Protect IP

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Written on: February 25, 2023

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– The Best Practices for Small Businesses to Avoid Scams and Protect IP when outsourcing to China

Outsourcing production to China can be a cost-effective way for small North American businesses to manufacture their products. However, it’s important to be aware of potential scams and fraud when dealing with Chinese suppliers. In this blog post, we’ll discuss some practical tips on how to avoid scams and fraud when outsourcing production to China, including the importance of due diligence and China NNN agreements.

If you’re looking for reliable legal services in relation to these issues, be sure to check out fixed-price services provided directly by experienced, vetted lawyers.

Things that you should NOT do when outsourcing to China

1. Do not blindly trust a supplier’s claims. Doing your own research and verifying the supplier’s claims before engaging in business with them is important. Ask for references and follow up with those references to confirm the supplier’s reputation.

2. Do not rely solely on email communications. Email is not always a reliable form of communication in China, and miscommunication can occur. Consider using phone calls or video conferences to clarify any questions or concerns.

3. Do not assume that your intellectual property is protected just because you have registered your trademark or patent in your home country. China operates on a “first to file” system, which means that even if you have used a trademark for years, someone else can register it in China and claim ownership. Therefore, it’s important to monitor your trademark and take action against any potential infringement.

4. Do not rush into a large order without testing the supplier’s capabilities with a small order first. It’s better to start small to test the quality, communication, and delivery of the supplier before committing to a large order.

5. Do not assume that the contract provided by the supplier is adequate to protect your interests. The contract may be biased in the supplier’s favour, so it’s important to have a lawyer review the contract and negotiate any necessary changes to ensure that your interests are protected.

Things that you should do when outsourcing to China

1. Engage a local lawyer to conduct due diligence

Before selecting a supplier in China, it’s important to do your research. Check the supplier’s background, reputation, and experience. One of the best ways to do this is by engaging a local lawyer in China to conduct due diligence on your potential supplier. A local lawyer will be familiar with Chinese laws and regulations and can help you verify the supplier’s legal status, ownership structure, and credibility.

The due diligence should also check on the controlling shareholder of the supplier to confirm the controlling shareholder is not a competitor of yours, which means a higher risk of IP theft. Additionally, the due diligence should confirm the supplier is not bankrupt or on the untrustworthy people list (the so-called “失信被执行人” in Chinese).

All these important items can be verified within 3 business days through a due diligence service by a Trustiics vetted lawyer. (Check out Due Diligence service.)

In addition, you should regularly, say every 6 months, have updated due diligence on your Chinese supplier to ensure that the supplier continues to be in good standing.

2. Register your trademarks in China

When outsourcing, you’re basically entrusting your intellectual property and designs to a foreign supplier. It’s important to protect your brand and logo by registering your trademarks in China. This will give you legal protection and the ability to take legal action against anyone who infringes on your trademark. You may also want to consider registering your patents and copyrights in China as well.

3. Sign a tailor-made China NNN Agreement

To further protect your intellectual property, you should consider signing a specific, tailor-made China NNN agreement with your supplier. This agreement can be customized to fit your specific needs. It can help prevent the supplier from copying or using your intellectual property without permission, as well as from unfairly competing with you by misusing your design or circumventing you to sell products they made based on your IP or design. Learn more about what is the so-called NNN agreement in this blog China NNN Agreement Explained in Plain English.

Be sure to check out China NNN agreement drafting services and other fixed-price legal services to help safeguard your valuable intangible secrets.

4. Start with a small order

It’s always a good idea to start with a small order when working with a new supplier in China. This will give you a chance to test the supplier’s quality, reliability, and communication. You can then gradually increase your order size once you’re confident in the supplier’s ability to meet your needs.

5. Use a secure payment method

When making payments to your Chinese suppliers, it’s important to use secure payment methods, such as escrow or letters of credit. These payment methods can help protect you from scams and fraud.

China banned all cryptocurrency transactions. So be mindful of that, even if it might work for your business in other markets.

6. Have a clear, tailor-made contract

Before working with a supplier in China, it’s important to have a clear and detailed contract. The contract should outline the scope of work, quality standards, delivery dates, payment terms, and dispute resolution procedures. Make sure to have the contract reviewed by a lawyer who is familiar with Chinese law and has experience in the Chinese market. A well-drafted contract can help prevent disputes and provide you with legal protection.

In conclusion, outsourcing production to China can be a cost-effective way for small North American businesses to manufacture their products. However, it’s important to be aware of potential scams and fraud when dealing with Chinese suppliers. By engaging a local lawyer to conduct due diligence, registering your trademarks in China, signing a tailor-made China NNN agreement, starting with a small order, using secure payment methods, and having a clear, tailor-made contract drafted by a lawyer with experience in the Chinese market, you can help protect your intellectual property and minimize the risks of fraud and scams. With these practical tips in mind, you can outsource production to China with confidence and peace of mind.

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