By: Peter N. Rasmussen
Uploaded January 2020
By Alex Wu and Peter Rasmussen, Asia Base Law & Projects (Suzhou) Co., Ltd.
China is the land of contract manufacturers. The world’s factory. A question that buyers (foreign and Chinese alike) often ask their manufacturers in China upon seeing new product samples in their show room is:
If the design belongs to another customer a good supplier will say no to such a tempting proposal. A bad one will try to circumvent and use their customer's business secrets to produce knock-offs…
It need not be dishonest suppliers only who may take advantage of knowing your business secrets. If you partner up with a company that puts in a lot of efforts into helping you adapt and produce a certain product based on your technology and knowhow – it can be expected that once you stop the business with that partner they will feel it is justified that they continue to use what they have learned.
Over the years it has become evident that in such cases the traditional “Non Disclosure Agreement” (NDA) most often is not protecting the owner of the technology well. So, what do you do to protect yourself against unauthorized use of your business secrets by a partner or supplier?
These days there is a lot of talk about the so-called "NNN agreement" (Non-Disclosure, Non-Use and Non-Circumvention agreement). What is this all about?
Prior to entering into a business relationship with a Chinese company, foreign companies are encouraged to identify and safeguard business secrets that may be shared with Chinese business partners and to implement appropriate measures to minimize risks of disclosure and misuse.
While trademarks and patents are protectable even after they are disclosed to the public, business secrets are not. If "the cat is let out of the bag" so to speak, it is all too late. Disclosing business secrets to a partner carries the risk that the partner may use the secrets to their own gain and end up as a competitor. This goes for joint-ventures, and even suppliers who need to know business secrets or sensitive information in order to be able to supply a certain product. Therefore, in any case of transfer or disclosure of business secrets to a partner or a potential partner there is a need to protect the disclosing party from misuse by the receiving party. In China such protection may be more complicated than in the West and precautions need to be more thorough.
In China, it is generally not considered unethical for a manufacturer to attempt to use confidential information obtained from a business partner for his own advantage, and therefore special caution is advised for foreign companies revealing business secrets to Chinese counterparties. The traditional Non-Disclosure Agreement (NDA) that most companies use when dealing with Chinese suppliers and business partners don’t really offer much protection. It normally doesn’t cover the USAGE of confidential information – only the DISCLOSURE of it.
Protecting information from unauthorized use and undue competition in China is best achieved by executing a so-called NNN agreement. This is an agreement that provides additional layers of protection not included in a standard NDA. As such, the NNN agreement serves three main purposes:
1. Non-disclosure: This part of the NNN agreement prohibits confidential information from unauthorized disclosure by the receiving party, as does a standard NDA.
2. Non-use: This part of the NNN agreement prohibits the receiving party from using the information obtained to compete with the disclosing party’s business activities.
3. Non-circumvention: This part of the NNN agreement prohibits the receiving party from circumventing the agreement and using confidential information indirectly to help other companies compete with the disclosing party or otherwise obtain an advantage of any nature or a personal gain.
The NNN agreement should be acknowledged, read and executed by all individuals who will be granted access to confidential information, including the receiving party’s subcontractors. If it is not feasible to have all subcontractors execute the NNN agreement it may contain a provision specifying that the receiving party is solely responsible for the subcontractors’ usage of the confidential information.
To ensure the NNN agreement is binding and to dissuade the Chinese counterparty from breaching its terms, the agreement should contain a well-defined financial penalty payable by the Chinese counterparty in the event of breach. The possibility of being liable to pay predetermined damages serves as a deterrent to the Chinese counterparty. The amount of the monetary damages specified in case of breach must be low enough for it to be taken serious by the Chinese court and high enough to dissuade the counterparty from violating the terms of the NNN agreement. Setting the actual amount is more of an art than a science. Make sure it is relative to the actual potential damage and to the financial ability of the Chinese counterparty. Chinese courts will normally not award compensation for breach of an NNN agreement if it would bankrupt the Chinese counterparty. If such levels of compensation are necessary – choose a bigger counterparty.
If you want to be protected in China – then protect yourself in China It can be difficult, if not impossible, to enforce decisions rendered by foreign courts of law in Chinese courts. Therefore set the governing law of the NNN agreement to the laws of China and the place of arbitration to a well reputed Chinese arbitration institution (yes, these exist!). This improves the enforceability of the NNN agreement in China.
To avoid misunderstandings between the parties, the NNN agreement should be drafted in Chinese, with or without translation into a foreign language. If for example an NNN agreement is available solely in the English language, Chinese courts will require the translation of it into Chinese anyway.
The NNN agreement provides a wider scope of protection with regards to confidential information than the traditional NDA agreement. Meanwhile, foreign companies doing business in China are encouraged to use additional means to protect their business secrets.
First and foremost, limit the communication of confidential information to that which is absolutely necessary. Ensure that the information is properly coded and not distributed to anyone unless they have a genuine and legitimate need to know. When practical, ask the receiving party for proof of additional layers of security. This may include password protection, biometric security measures, and even CCTV monitoring. This is China, and there are security cameras everywhere. Generally being monitored is accepted by the public and in the workplace. These precautions should be considered an addition to the proper drafting and execution of an NNN agreement.
The NNN agreement is not fool proof, but it is a good step in the right direction. As with everything else in China - you need to be on your toes to expose infringements and violations, and you need to take action. Always be both active and proactive.
At Asia Base we help foreign investors and entities select and evaluate potential partners and create partnerships in China. One crucial aspect of that is to safeguard confidential information and trade secrets. On www.asiabase.com you may download a copy of our standard dual language NNN agreement template (click here).