China NNN Agreements: Essential and NOT for Trade Secrets

When my law firm’s international manufacturing lawyers  work on international manufacturing arrangements, we never just draft a “straight NDA.” Instead, we draft a “non-disclosure/non-use/non-circumvention agreement” that we refer to as an NNN Agreement.

Why? Because a Western-style NDA is worthless or worse for China. For China, you need a China-specific NNN Agreement.

1. China NNN Agreements are Essential

When a foreign company client contracts with a foreign/Chinese company to manufacture a product, the NNN focuses on the three primary “bad acts” the foreign company needs to prevent:

1. The foreign company does not want its design revealed to a third party. To prevent this, a non-disclosure agreement is required. Though this is an important issue, disclosure to an entirely unrelated third party is actually fairly uncommon with China manufacturers. The bigger risk is disclosure to a related party. Many Chinese businesses have multiple subsidiaries and manufacturing is done through large networks of subcontractors. Chinese companies are quite relaxed about passing around information within this network. A good non-disclosure agreement/provision must focus on controlling information within a network your Chinese manufacturer itself does not consider as falling within the scope of a non-disclosure requirement.

2. The biggest concern of the foreign company is usually not disclosure to a third party. They are usually most concerned about preventing their Chinese manufacturer from making use of the foreign company’s own product design to compete with the foreign company. For this purpose, a non-use agreement is required. A good non-use agreement focuses on two things. First, the agreement identifies the applicable intellectual property or confidential information of the foreign company and then authorizes the Chinese manufacturer to use that intellectual property or confidential information solely to manufacture products for the foreign company. Second, the agreement requires the Chinese manufacturer agree not to manufacture the product or any similar product other than for the foreign company. This second provision prevents the Chinese manufacturer from manufacturing a similar product under its own trademark. Since many products are not covered by patents or trademarks or other IP protection, the only way to prevent such “copycat” manufacturing (for which China is deservedly famous) is with such a non-use provision. Normal IP protections will not work, so a contractual agreement is essential. NDAs utterly fail to account for this.

3. The foreign company also does not want its Chinese manufacturer to go around (circumvent) them by selling their product directly to the foreign company’s existing or future customers. After the Chinese manufacturer has manufactured the product for some time, it will likely have learned about the market and the customers for the product and you do not want that manufacturer to then go to your customer and say: “Look, we are the company actually making this product and since this product has no patent or other IP protection, why don’t you just buy the product directly from us, for a lot less?” This is called circumvention and it is extremely common in China. If you want to avoid getting “cut out” in this way, a non-circumvention agreement is required. Again, NDAs just ignore this.

2. China NNN Agreements are not for Trade Secrets

When a Chinese manufacturer receives an NNN Agreement, they often suggest revising certain terms and conditions that will neutralize our client’s ability to protect their confidential information. One suggested revision we commonly see — especially from Chinese State Owned Enterprises (SOEs) — is that the Chinese manufacturer wants to change the term “confidential information” to “trade secrets.” Though this change sounds reasonable, agreeing to it would be highly detrimental to the disclosing party/foreign company. If the standard common law style trade secrecy-based exemptions are included, the confidential information provisions in the NNN Agreement effectively become unenforceable under PRC law. Your Chinese manufacturer will claim that the confidential information was not a trade secret, and the Chinese court will virtually always agree.

We discovered this early on in our work in the PRC and that is why we write the confidentiality portion of NNN provisions purely as a contractual obligation. Our China NNN Agreements. provide that any information our client provides to its Chinese manufacturer is protected as provided in the NNN Agreement. It does not matter if the information is a secret. It does not matter if everyone in the industry knows the information. Sometimes, when appropriate, we will make a limited exemption: The NNN provisions do not apply if the manufacturer can prove that it already knows the information and it is actively using the information in its current production. No PRC manufacturer has ever provided this proof. PRC manufacturers, of course, do not like being restricted with the information they are provided. Objections used to be rare, but in the past two years, objections have become more common, particularly for SOEs. However, we never include the exemptions that go into common law NDA Agreements because providing for nothing in writing is better than a provision that is unenforceable on its face.

The exemption matter arises from a basic legal confusion. Under U.S. and PRC trade secrecy law, as a matter of intellectual property ownership, a trade secret is only protectable property if secrecy is maintained. Once secrecy is broken, it is no longer a trade secret and there is nothing to protect. This is the reason for the standard exemptions you see in common law NDAs. Our NNN language has no relation to “trade secrecy as property” law. Our NNN provisions are not concerned with disclosure from the standpoint of protecting a trade secrecy property right. Our NNN provisions are concerned with the contractual non-use and non-circumvention provisions. Disclosure is not focused on breaking secrecy. Disclosure is focused on preventing the disclosure to related entities, family-owned entities, and subcontractors where those third parties will violate the non-use and non-circumvention provisions. We are not concerned with breaking secrecy because we start from the assumption that confidential information is not a trade secret under U.S. and PRC law. It is because of this assumption that the contractual NNN provision is required.

Our NNN language has been tested over the last 15+ years and it works very well. When PRC manufacturers refuse to sign, this is because they know that our NNN provisions will be enforceable in Chinese courts. They know that they will not be able to use the “it’s not a secret” trick to escape liability. Some don’t sign because they simply don’t want to be restricted. Others don’t sign because they are planning to steal from our clients. Either way, our client benefits from learning up front that these are not safe companies and they should move on from them

Arlo Kipfer

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