China: China Litigation And Arbitration, Part 3: China Consultants And The Liabilities THEY Face

Our China lawyers often work with many really experienced and really good China consultants. These consultants are usually really good for the following reasons:

• They know the ins and outs of what it takes to succeed in doing business in China and with China.
• They know the ins and outs of how to find good Chinese companies for whatever transaction it is their clients are seeking to do in China because they know how to distinguish between a good company and a bad Chinese company.
• They know the ins and outs of how to negotiate with Chinese companies.
• They know when to bring in a China lawyer to assist.

Of course I had to add that last one, but the truth is that just about every China sourcing consultant I know has violated this last one a few times. And — no surprise — it is on this last one of which I am writing.

China consultants too often fall short in the legal aspects of their own business. They have been "doing China" for so long that they seem to lose sight of the fact that when push comes to shove (or as lawyers like to say, when a deep and easy pocket needs to be found) they are the American/British/Canadian/Australian company that may need to answer for what happened. If you are a Western consultant hired by a Western company to assist it in doing any sort of business in or with China, you need to understand that if something goes wrong for your client you will be your client's first choice for legal redress. Not only is there a good chance that you have the deeper pocket (or at least the easier pocket to reach into) but you will almost certainly be easier to sue for the simple reason that you are likely going to be almost right next door, not on the other side of the earth.

What can go wrong for China consultants that can lead to their incurring liability? And what can you as a China Consultant do to prevent or ameliorate such a problem? Our first advice whenever a company comes to us with concerns about protecting against future liabilities is to engage in corporate structuring to protect company and personal assets. This is an absolutely necessary first step. Looking at securing insurance protections is oftentimes a good second step. Beyond that however, and more specifically to China, you can do a lot to protect your client and thereby protect yourself. See yesterday's post, China Arbitration and Litigation, Part 2: First Check Your Insurance Policy, on how insurance can be relevant in China litigation and arbitration matters even in situations where you would not expect it to be.

We have lately been seeing a rash of problems with sourcing consultants that assist in finding Chinese manufacturers and this post will focus on those consultants, leaving to future posts the issues our China attorneys are seeing with other sorts of China consultants.

A typical China product sourcing project, might go down as follows:

1. Western company retains a product sourcing consultant to find the best Chinese widget manufacturer, based on cost, quality, and dependability.
2. The product sourcing consultant requests and secures a sample widget from a number of Chinese manufacturers, many of which it may have conducted business previously.
3. The consultant meets with countless Chinese manufacturers in search of the best one.
4. The consultant recommends company Z in China to manufacture 200 million widgets.
5. The consultant is to be paid a percentage of the manufacturing costs, oftentimes with that percentage set to decline over time.
6. Company Z starts manufacturing the widgets.

Now let's deconstruct this hypothetical project above and note where the consultant has potentially harmed the client and needlessly taken on huge liabilities.

The China consultant agreed to find "the best Chinese widget manufacturer." Is that the best widget manufacturer in China or the best in the world? What if one Chinese widget manufacturer charges one hundred dollars per widget for 200 million widgets, but your client's competitor finds another widget manufacturer who will do it for ninety dollars. Is the China consultant liable for the ten dollar difference? Even worse, what if a competitor of the China consultant's client gets the same Chinese widget manufacturer to manufacture its widgets for ten dollars less? Will a U.S. jury believe the China consultant was doing its best on pricing when its fee ended up being larger because the Chinese manufacturer was able to charge more? Is the China consultant responsible for the Chinese manufacturer's late deliveries? Is the China consultant responsible for the Chinese manufacturer's bad product? Whose fault is it if 100 people are badly injured due to the widgets being defective? Is it clear exactly on what the China consultant's percentage is based? Is there anything to prevent the China consultant's client from entering into a new deal with the China manufacturer the China consultant found and negotiated the manufacturing arrangement?

If you take a product sample to China and start showing it to potential manufacturers without having FIRST put various intellectual property safeguards in place, you are courting disaster. Your sample could be used for counterfeiting and the trademark on the sample (or your client's name) could also be stolen. In November, I wrote an article for Forbes Magazine, Why Your NDA Does Not Work For China, explaining why a Western-style NDA is usually worthless in these situations. That article alone got me two calls from panicking China consultants in a panic asking whether they could be held liable if their client's lose their IP to China. My answer was that would likely depend on the contract they have with their clients and the role they play for their clients. The long silences I got in response to this led me to believe that neither had anything in writing with their clients and that both had touted their companies as a complete China solution for their clients.

And that right there is the big trap into which China consultants too often fall. In trying to secure clients they encourage their clients to believe that they are experts on everything China and that is what often can come back to bite them.

Just last week I received emails from two different China consultants regarding extremely complicated and potentially major intellectual property issues faced by their clients. In both cases, I explained very generally the issues their clients would likely be facing and in both cases the consultant wrote me back to tell me how they would be handling the situation in the short term. And in both cases the consultant's planned advice would not have been appropriate. So I wrote back something like the following:

And that is the point. As a consultant it rarely behooves you to get in the middle of your client's complicated China legal issues and they should not expect that of you. Even if you as their China consultant caused your client's complicated China legal issues, your trying to solve them will more often than not simply compound them.

So what is the solution for China consultants? A written contract between your consulting company and your client before you start work. This contract should make clear exactly what it is that your consulting company will be doing and that these enumerated items will be its only responsibilities.

The problem we consistently see, however, is that product sourcing consultants usually oversee their clients' OEM agreements with the Chinese manufacturers and by doing so, they subject themselves to major liability issues if that contract is not up to snuff — and it virtually never is.

If your company is selling itself as the "China people" or the "China experts" and your clients are counting on your company to guide it through China's business minefields, then your company will be expected to know anything and everything about what it takes to do business in China. And if something goes wrong in China, a Western court will likely expect you as the China expert to have been the one to have known better. For example, if your client loses its IP in China because it believed that its US or Canada or Australian or EU patents and trademarks extended to China (they don't), you as their China consultant may find yourself on the hook for not having warned them otherwise.

Bottom Line: At minimum, China consultants should put in writing with their clients that they do not provide legal advice and that their clients should retain their own lawyers for that. And that stick by that and refuse to provide any such advice.

China consultant, protect thyself.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.