Sourcing Your Products From China, Your Intellectual Property - Part 2

BUSINESS

By Merritt R. Blakeslee

Sourcing Your Products From China...

...Without Losing Your Shirt, Your Intellectual Property or Your Customers, Part II

This is the second in a two-part series on issues to consider
when sourcing products from China (and other countries). See Part I in
the SEMA News December 2007
issue, which outlined the risks specific to sourcing from a Chinese
supplier and offered techniques for minimizing and managing them.

It goes without saying that you should continually monitor the
market for products that violate your intellectual property rights, and
that is true whether or not you source in China.

Safeguarding Your Intellectual Property Against Misappropriation by Your Supplier or Others

A. Preventing the Theft of Your Intellectual Property

When sourcing from a Chinese supplier, you must take steps to
protect your intellectual property: the trademarks with which your
products are branded; the copyrighted materials in your product
instructions, marketing materials and software; the patents on the
technology incorporated into or used to manufacture your products; and
any trade secrets covering your manufacturing processes. Here, the best
offense is a good defense.

It is important to understand that your intellectual property is at
risk whether or not you turn it over to your Chinese supplier. Chinese
manufacturers routinely reverse-engineer and copy products that they
obtain on the open market. Here are some tips on how to manage the
heightened risks to your intellectual property that go with sourcing
from a Chinese supplier.

1. Use due diligence in selecting your supplier.

Your search for a reliable supplier (as discussed in Part I) should
include an intellectual property audit of any prospective supplier to
determine what else it is manufacturing, for whom and whether there
have been any complaints related to intellectual property and any
evidence of unauthorized products being sold in China or the United
States. You may wish to run a background check on key personnel.

2. Protect your intellectual property through contractual provisions.

In protecting your intellectual property, prevention is better than
enforcement—and prevention begins with well-drawn contractual
documents. Your contract should include a non-disclosure section in
which your supplier agrees not to disclose either (a) your company’s
confidential business information or (b) confidential intellectual
property (for example, a trade secret). It should also include language
specifying that your supplier does not have a license to use your
intellectual property except in connection with products manufactured
for and delivered directly to you. In addition, you should work with
your supplier to raise his intellectual property awareness. Finally,
the use of an inspection agency to monitor the activities of your
supplier (as discussed in Part I) is also a safeguard against the theft
of your intellectual property. These are prophylactic methods and, like
washing your hands to prevent catching a cold, they are necessary but
not fool-proof.

With respect to trademarks, you should know that China has a
“first-to-file” system that requires no evidence of prior use or
ownership, making it legal for an unrelated party to register your
trademarks in China.

3. Hold on to your intellectual property and trade secrets.

If you do not turn your intellectual property over to your Chinese
supplier, it makes it more difficult—although not impossible—for your
intellectual property to be misappropriated. Some companies source only
semi-finished goods from China and add the items critical to
intellectual property during final manufacturing in the United States.
To protect your patents, you can add the patented component—or perform
the patented process—once the product reaches the United States. You
can do the same with trade secrets—by using them only in the United
States. You can ensure that your trademarks are affixed only in the
United States. This may mean that you provide display packaging only in
the United States. Final steps to prepare your products for sale—e.g.,
any proprietary software programming—should be performed in the United
States, if possible.

Obviously, this involves significant trade-offs. It may be
advantageous or even essential for you to be able to source fully
finished and packaged products from the Chinese; that is, after all,
why you went to China in the first place. On the other hand, to obtain
the greatest possible protection for your intellectual property, you
would stay away from China entirely, although, as mentioned, even that
does not guarantee that your intellectual property will not be
misappropriated. A workable solution lies somewhere between these
extremes, and you must decide where to draw that line.

4. Monitor the market.

It goes without saying that you should continually monitor the
market for products that violate your intellectual property rights, and
that is true whether or not you source in China. To monitor for
intellectual property problems related to your production in China, you
should monitor Asian and European trade shows, as well as trade shows
in the United States; websites; B2B bulletin boards, such as
Alibaba.com; and publications, such as the China Transportation
Equipment Guide, which is distributed at the SEMA Show and to which you
can subscribe.

B. What to do if your intellectual property is stolen.

If your intellectual property is stolen, you have two main choices,
and they are not mutually exclusive. One is to take action to bar the
importation of infringing merchandise into the United States. The other
is to take legal action in China.

Your options for taking action in the United States are: working
with the Bureau of Customs and Border Protection and the Bureau of
Immigration and Customs Enforcement to prevent importation; filing suit
at the International Trade Commission to bar importation; or seeking an
injunction against importation in federal district court. All of these
remedies are imperfect because the protection you obtain extends only
to the U.S. market. Separate enforcement action is required in other
countries where you sell your products.

There are at least three different types of legal action that you
can take in China to combat the misappropriation of your intellectual
property: requesting enforcement by the local administrative
authorities; requesting the Chinese Customs Service to bar the export
of the products that infringe your intellectual property; and bringing
a civil suit in a Chinese court. It is essential to realize that before
you can take any of these three types of action to enforce your
intellectual property rights, you must register your intellectual
property in China. The Department of Commerce has posted on its website
an “IPR Toolkit—Intellectual Property Rights in China” (www.stopfakes.gov)
that explains what is involved in registering your intellectual
property in China. With respect to trademarks, you should know that
China has a “first-to-file” system that requires no evidence of prior
use or ownership, making it legal for an unrelated party to register
your trademarks in China.

U.S. companies have experienced mixed and often disappointing
results in attempting to enforce violations of their intellectual
property through the administrative agencies that enforce intellectual
property rights in China. On the other hand, Chinese Customs has been
effective in preventing the exportation of infringing merchandise, but
its effectiveness depends on receiving accurate, timely information
from you about the movement of infringing goods—and this is information
that you may not possess.

Therefore, most U.S. companies that seek enforcement of their
intellectual property rights in China file suit in a civil court. China
has established specialized intellectual property panels in its civil
court system throughout the country. You could bring a suit for
intellectual property infringement—or possibly for breach of
contract—and this is the most effective means of resolving problems
but, as noted, it is far from perfect.

Most U.S. companies that seek enforcement of their intellectual
property rights in China file suit in a civil court. China has
established specialized intellectual property panels in its civil court
system throughout the country.

Protecting the Integrity of Your Supply Chain—Midnight Runs and How to Avoid Them

A so-called “midnight run” is the unauthorized manufacture of your
product by your supplier. The name supposes that the supplier produces
your product for you during normal business hours and runs an extra
night-time shift to manufacture additional units, which the supplier
then sells into the gray market.

This type of unauthorized manufacturing of your product does not
necessarily involve a violation of your intellectual property rights,
although if the manufacturer reproduces your trademarks, copyrighted
instructions, software or patented technology, then, in addition to
violating your trust—and its contract—the supplier has misappropriated
your intellectual property.

Here again, well-drawn contract language and good onsite inspection
are the first lines of defense. In addition, two techniques will give
you further protection against diversion by your Chinese supplier:
withholding or rationing key components that make the product
marketable, and ensuring that your products are marked in a way that
will permit immediate determination in the field whether a product with
your company’s name on it is authorized or not.

It is a matter of common sense that if you do not entrust your
supplier with the responsibility for manufacturing components or
products that are salable as is (i.e., without the necessity of further
manufacturing), then it is harder for a supplier to sell any
unauthorized units of your product that it manufactures without your
knowledge. In other words, midnight runs are less of a problem with
semi-finished products than with components or fully finished goods.
Thus, one defense against midnight runs is to complete the
manufacturing process in the United States. This is particularly
effective if you withhold a component that is difficult to copy or
reproduce.

If your business plan requires full assembly by the supplier, you
can still protect yourself by shipping a key component from the United
States in carefully regulated quantities. For example, Levi Strauss has
the tags for its “401” blue jeans produced in the United States with
sophisticated anti-counterfeiting technology, and it carefully ensures
that for every tag that it sends to its supplier, it receives a pair of
jeans in return. A number of companies in the United States will
provide this type of security relatively cheaply.

In addition, it is essential that you ensure that your products are
carefully marked—by individual serial number or at least by lot
number—so that when you find suspect products in the marketplace, you
can immediately determine whether they are products whose manufacture
you authorized. The marking should give information on date of
production, location of production facility, lot number, etc. Ideally,
each unit should bear an individualized mark, and this mark should be
readable in the field, i.e., with a handheld scanner. If the wheel
manufacturer with the broken wheel and the product liability suit
mentioned in Part I had employed this type of marking, he would have
been able to show that the broken wheel had been manufactured without
his authorization.

 

Intellectual Property Webinar Available

A discussion of the means of preventing the importation of your
misappropriated intellectual property is outside the scope of this
article. However, in September 2005, this article’s author gave a SEMA
webinar entitled, “Why Your Company’s Intellectual Property Is a
Valuable Asset and What to Do to Protect It From Infringement,”
discussing precisely this topic. That webinar can be accessed on the
SEMA website at Programs and Services/Education/Webinars (www.sema.org/main/semaorghome.aspx?id=51488).

 

Protecting Against the Theft of Your Customers

When your supplier sells your product—or an equivalent product—to
entities who have been buying directly from you, the supplier has
stolen your customers. Because SEMA members generally supply the
automotive aftermarket rather than the OEM market, theft of customers
can be slightly less of a problem because many high-performance
aftermarket products are sold on the basis of their brand name and
trademarks. Nevertheless, there is a danger of customer theft,
particularly where your supplier offers your product with different
markings. The rules for protecting against the theft of your customers
by your Chinese supplier are common-sense ones:

  • Include contract language that prohibits your supplier from selling
    your product—with or without your markings—to anyone except you.
  • Don’t have your supplier drop-ship your goods to your customers.
  • Don’t disclose your customer lists to your supplier.
  • Watch for a drop-off in orders from your customers.

RESOURCES

Merritt R. Blakeslee, a partner in the Washington, D.C. office of deKieffer & Horgan (www.dhlaw.com), has practiced in the field of international law and trade law regulation since 1991. He
advises clients on compliance with U.S. and international trade
regulations and represents clients before federal agencies and U.S.
courts on a wide variety of issues, including the enforcement of U.S.
intellectual property rights against imported merchandise, antidumping
and countervailing duty proceedings, Customs issues (including proper
classification and valuation of imported merchandise) and general
commercial transactions. He may be reached at
mblakeslee@dhlaw.com.

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