China IP Protection: Good Luck With That

One of the recurrent (sometimes underlying, sometimes explicit) themes of this blog is that if you combine best legal practices with best operational practices, you’ll do just fine in China.

For the second time in the last few months, this proposition has taken a major hit.

We are always preaching that if you 1) choose a good manufacturer, 2) use a China Manufacturing Agreement 3) engage in good quality control monitoring, and 4) register your trademark, the odds are overwhelming you will do just fine in outsourcing your product manufacturing to China.

In 2009 and 2010 and the first half of 2011, I my firm would receive maybe two emails a month from someone who had sent money to a Chinese manufacturer and received no product. And of those emails, nearly involved a relatively unsophisticated buyer who had done none of the four things listed out above.

In the last three months or so, we have received probably 4-5 emails from buyers who have been burned by Chinese manufacturers but have a very different story to tell. These buyers have been burned by Chinese manufacturers with whom they have been dealing successfully for many years.

Now today I learned about a foreign company that appears to have done everything right and yet still had its IP stolen in China. This all comes from a BusinessWeek article, China Corporate Espionage Boom Knocks Wind Out of U.S. Companies highlighting what happened to American company, AMSC.

Let me backtrack a bit first. Both here on this blog and in real life with our clients, we are always saying that companies must do two things to protect their intellectual property/trade secrets from Chinese (and other) companies: protect them legally and protect them operationally. One without the other does not make much sense. For example, my law firm’s international IP lawyers  can write the world’s best NNN Agreement, but every time you show your secret design or formula or whatever to a Chinese factory or company, the odds of your IP getting stolen increase. If you can get away with showing just a portion of your secret design or formula, the odds decrease.

To trust is nice, to control better. Know what is going on with your IP in China at all times and use “several anti-counterfeit technologies.” In other words, do not rely solely on the law to protect your IP in China.

Let’s face it, though a good contract and a good IP registration increase the ability to trust, neither of them equal total control.

That is why we suggest to our clients that whenever possible, they operate in such a way that even if some of their IP is stolen, all of it cannot be. By way of example, I often mention a client of ours who has a hardware/software product that cannot function optimally unless both are working together. This company keeps its software on a server at its home office in the United States so as to make it virtually impossible to copy. On top of that, even if it were copied, it would rapidly become out of date due to the lack of updating critical data. When I discuss this company, I often describe it as having found the “magic key” and I suggest to our clients that they too try to find their own “magic key.”

But based on what happened to AMSC, even magic keys are not so magic.

AMSC’s China business was not atypical:

AMSC began packaging the electronic components and selling them to China’s small but growing domestic manufacturers, which had plenty of capital and cheap labor to make the turbines’ steel skeletons but lacked the sophisticated gadgetry to run them. The arrangement was working the way it was supposed to: China would turn out the commodity hardware — the turbines — and a U.S. company would retain control of the high-margin intellectual capital-end of the business.