Distribution, Purchase and Licensing

In addition to the establishment or acquisition of companies in China, it is also possible to enter the Chinese market without involving direct investment and local recruitment. For instance, sale of products can be achieved directly from Germany, or through cooperation with Chinese sales agents or distributors, or by granting license.

1 Distribution from Germany

 

The legal requirements for distributions directly from Germany to China are rather low. A conventional purchase contract, which can be subjected to the laws of any jurisdiction selected by the parties, is sufficient. For dispute resolution, the parties may agree on any court or arbitral tribunal. As there is no convention on mutual enforcement of court decisions between Germany and China, choosing a German court from enforcement point of view only makes sense if the Chinese business partner also has assets in Germany. Therefore in practice, the parties usually agree on arbitration.

 

It should also be aware, that the enforcement of any claims against Chinese debtors in China is extremely difficult. Therefore it is advised to include risk-minimizing payment clauses in the contract (e.g. advance payments by instalment according to the progress of service delivery).

Although documentary credits (Dokumentenakkreditive) are a good alternative and usually offer sufficient protection, a confirmation about documentation by a western bank should always be requested as Chinese banks require very strict compliance with the agreed documents. Due to the policy of foreign exchange control, however, this payment method is not always accessible to Chinese buyers.

 

Customs procedures in China tend to be very strict too. In order to avoid problems during customs clearance, the foreign supplier should communicate closely with its Chinese costumer in preparation of the delivery. Furthermore the supplier should also request the costumer’s instructions in writing and then proceed exactly according to these instructions. In doing so, some problems may be avoided; and on the other hand, the Chinese customer is reasonably obliged to share some of the risks.

 

The same applies to any product certifications that might be required, in particular those required by the CCC (China Compulsory Certification) regulation. It is advisable to contractually specify that certificates are in the costumer’s responsibility, so that the foreign seller fulfils his obligations by just following the costumer’s instruction.

 

In addition, extra caution should be given to price inquiry coming from unknown sources. For some years, organized gangs in China send out large numbers of such price inquiry to foreign companies. Once replied, the foreign company will then usually be invited to come to China for contract negotiations, and be asked to bear significant costs in connection with the negotiations, such as overpriced dinner invitations and gifts for supposed end customers. After making those expenditures, the formerly “interested” buyers are no longer reachable.

 

Our consulting services on supply relationships to China include:

 

  • Credit check of Chinese customers, in cooperation with specialized credit reviewers
  • Drafting and negotiation of sales contracts, including complex facility supply contracts (Anlagenlieferverträge)
  • Formulation of terms of payment
  • Implementation from legal perspective of customs clearance and product certification procedures, in cooperation with specialized partners
  • Supervision from the technical perspective of product certification procedures, in cooperation with specialized technical consultants

 

2 Cooperation with Chinese sales agents and distributors

 

Due to the size of China’s territory and the necessity to build personal relationships with certain costumers, many foreign companies choose to cooperate with Chinese sales agents and distributors.

 

When selecting sales partners, industrial knowledge and professionalism should always be checked in details. The qualification of a potential partner is often reflected by its personal connections with managers of a potential major customer or with the competent supervisory authorities, which involves significant risks on regulatory compliance issues and uncertainty for a long-term business relationship.

 

It is suggested that a nationwide distribution network should be organised on two levels. On the first level, a master agent who is responsible for import, attending fairs and promoting products, customer service and acting as the technical centre of the products. On the second level, regional or industry- specific sub-agents who perform the actual order acquisition based on their knowledge of each customer.

 

The contracts with sales agents and distributors should be structured in a way that on the one hand the Chinese partners have sufficient security to plan ahead and to make the required investments to build up the business. On the other hand, the foreign partner shall be able to end the partnership, if the expected marketing performance is not fulfilled or it is suspected that improper means such as corruption are used to acquire orders.

 

Our consulting services concerning the cooperation with Chinese sales agents and distributors include:

 

  • Structuring of the sales activities
  • Identification and check of suitable sales agents
  • Drafting and negotiation of the agency or distribution agreements
  • On-going monitoring of the lawfulness of sales activities

 

3 Licensing

 

Licensing is usually initiated by potential Chinese licensees. It is advised that caution should always be exercised when granting license. On the one hand Chinese law provides several mandatory rights for – generally Chinese parties- Licensees. In particular, the licensee is entitled to further develop the provided technology and the intellectual property right of the new development automatically goes to the licensee. On the other hand, it is practically difficult to prevent the gained know-how by the licensee from being used by a third party but with no involvement of the licensor. Finally, the reports on the generated income from the licensed know-how do often not reflect the truth.

 

Licensing should therefore, as far as possible, be limited to cases where the licensee is obligated to buy parts and components from the licensor in order to apply the licensed technology for product production. Where the technology to be licensed is not valuable for the licensor anymore, the negotiation shall be strived to set the licensing fee as equivalent to the price of technology transfer.

 

This is of course different, if the licensee is an affiliated company with the licensor. Especially in case of JVs, it is often an advantage not to inject required know-how as an investment contribution, but in the form of a license agreement with the JV. By doing so, the know-how does not need to be evaluated by the competent authority and the license agreement can be terminated in the event of a breakup of the JV.

 

In any case, licensing of technology in China is always subject to registration. Without proof of such registration licensees may not transfer the royalties abroad.

 

It should be aware that royalties are subject to a withholding tax and, where applicable, also subject to VAT.

 

Our legal services concerning licenses to Chinese licensees include:

 

  • Drafting and negotiation of the license agreement
  • Registration of the license agreement
  • Advice on relevant tax issues

 

4 purchasing from Chinese suppliers

 

Business activities do not only consist of distribution, but also of procurement, which is often the first business activity made by foreign companies in China.

 

China now has the largest manufacturing sector in the world, the supply of Chinese goods is extensive, and the manufacturing levels extended. Therefore, there is a huge potential for foreign companies to find products suitable for their own businesses.

 

However, the differences in product quality between Chinese suppliers are immense, without being able to form general categorizations. Irrelevant of State-owned or private, there are both reliable suppliers as well as those that do not yet meet Western demands.

 

In preparing purchasing from China, especially for a small quantity of products and only on an occasional basis, it has to be considered that the price advantage will quickly be offset by the higher cost of contract preparation and performance, transport costs and often long and uncertain delivery time.

 

Finally, supply by a Chinese company frequently is subject to an upfront transfer of know-how for production and quality control. This is particularly likely if the ordered products must meet certain European quality standards that Chinese suppliers are often not familiar with. This presents a significant risk of loss of know-how, which should be prevented by clear rules included in the purchase agreement and breach of those rules should trigger contractual penalties. These rules include, for example, that tools, made especially for the execution of the contract shall be the property of the purchaser and shall not be used for any other purposes; that the purchaser always has access to the supplier's factory; and that all technical documentation shall be returned or destroyed after the execution of the purchase contract. However unfortunately, even a very well written contract cannot guarantee that the provided know-how will not be misused especially for Chinese competitors.

 

In any case, it is always recommended to visit the Chinese supplier before placing an order, to learn about his capabilities and to agree on precise production and quality assurance processes. Advance payments should only be made by instalments based on goods delivery, if at all; and if possible, the status of service performance should be checked before the individual payments are made. The technical supervision of particular production process can be assigned to specialized companies such as the TÜV-organisations.

 

Our consulting services concerning purchasing from Chinese suppliers include:

 

  • Identification of potential suppliers
  • Conducting comprehensive audits of suppliers in cooperation with specialised technical consultants
  • Drafting and negotiation of purchase agreements
  • On-going monitoring of continuous production and proper delivery in cooperation with specialized technical advisors