China

Want To Protect Your IP From China? Use An NNN Agreement

What are the three Ns? Non-use, non-disclosure, and non-circumvention. Let’s look at each in turn.

By Dan Harris on November 16, 2015 11:02 am

Last week, in Want to Protect Your IP from China? Throw Your NDA in the Waste Basket, I explained why US-style NDAs are worthless for protecting IP from China companies and how what you really need is a China-centric NNN agreement. What are the three Ns? Non-use, non-disclosure, and non-circumvention. Let’s look at each in turn, using an American company working with a Chinese company on product manufacturing as the example. 

Non-use means requiring the Chinese factory to agree by written contract not to make any use of your idea/concept/product in a manner competitive with you, the disclosing party. The critical point is that this obligation arises by Chinese contract, not from some abstract property rights arising under intellectual property law. A written prohibition against use protects you not because your concept is classified as some form of intellectual property such as trademark, copyright, patent, or trade secret. The Chinese factory cannot use your work because it executed a contract agreeing not to use your work. Getting a factory to sign a contract with a non-use provision means there is no need to look outside that contract to other areas of law for you and China’s courts to control the Chinese factory.

The next element is non-disclosure. In most instances, American companies need not be terribly concerned with their Chinese counterparty making the American company’s secrets public. The Chinese factory usually has no interest in letting the general public in on their good thing; if they want to use your concept, they want to use it for their own purposes. They rarely have any interest in disclosing it to the public.

If you prohibit a Chinese factory from making direct use of your concept, the clever Chinese entity will not directly breach the non-use prohibition. It will instead simply disclose the concept to someone in their “group” and then accurately claim that it has not breached the non-use prohibition because it is not directly making use of the protected information.

For this reason, it is important that you understand the type of group with which you are dealing and you must make clear in writing that: 1) disclosure is specifically prohibited within the group and 2) if there is any infringement by any member of the group, the factory that made the disclosure is fully liable.

Often, some education on this issue is required because many Chinese companies do not see disclosure to a member of their group as violating a non-disclosure prohibition. The following are some of the most common situations we see when dealing with Chinese factories:

  • It is common in China for family members to own a large group of small- to medium-sized companies and for the family to consider all of these companies as the same entity for disclosure purposes.
  • Many Chinese factories use a team of constantly changing subcontractors. Some of these subcontractors are part of the family group, some are related by co-ownership, some are viewed as related only due to their physical proximity. The factory will often argue that it must disclose to these subcontractors to be able to provide costing for your product.
  • Many Chinese factories are part of a large and extensive “group company” arrangement involving numerous subsidiaries owned by a single parent. Members of the group do not see other members as outsiders for disclosure purposes.
  • Many state-owned enterprises do not see other SOEs as separate competitors. In their view, they are all state-owned and so information held by one company should be freely shareable with other SOEs. This is particularly true in sectors with a public service background, such as medicine, healthcare, and aeronautics. Since all the companies are pursuing the public good, they see no reason not to share your wonderful information with their brother SEOs.

Finally, you need to deal with non-circumvention. Your Chinese factory knows you are purchasing product at the China price and you will be adding on a big margin before you sell the product in the foreign market. Imagine now if your Chinese factory started contacting your customers and offering to sell your product at the original China price. Now imagine that after going through your customer list, your China factory starts marketing and selling your product to the rest of the world. What would your customers do if offered your product for 50% less? We realize that in many industries (especially those where quality and servicing is critical), most customers would say no. But in many other industries, they quickly and almost uniformly say yes. This is circumvention, and the only good way to prevent this is with a China-appropriate non-circumvention provision.

Now that you have thrown your worthless US-style NDA in the trash and have mastered the three Ns, a couple more steps remain. You must next ensure that your NNN agreement has the provisions required to keep the Chinese factory under control. I will discuss how to accomplish that in my next ATL post.

Dan Harris is a founding member of Harris Moure, an international law firm with lawyers in Seattle, Chicago, Beijing, and Qingdao. He is also a co-editor of the China Law Blog. You can reach him by email at [email protected].