Sourcing Product From China

Patents

We advise Mango to register its patent as an “invention” under the Patent Law of the People’s Republic of China, which is analogous to a utility patent in the US. Patent protection in China is subject to novelty, inventiveness and practicability. The qualified patent agent (who, like a trademark agent, is required for patent registration) can also assist and advise the client throughout the process. The registered patent agent can also assist in translating office actions, issued only in Mandarin, into English.

Mango will also want to take steps to protect its patent from infringement. Patent infringement in China, under Article 57 of the Patent Law, includes manufacture of the patent without authorization of the owner. It is essential to ensure that Silverwolf employees do not begin manufacturing knockoff orange boxes and selling them in violation of the patent. Mango can do this by including a clause in the manufacturing agreement prohibiting the manufacturer from stealing the patent.

Tariffs on Imports

Mango will be required to comply with the applicable customs laws of the U.S. and pay the appropriate tariff on its imported goods. The “Harmonized Tariff Schedules of the United States “ (“HTSUS”) provides the applicable tariff rates and statistical categories for all merchandise imported into the US. There are three steps in tariff calculation.

1.            Customs classification — under which category of the HTSUS do the goods fall?
2.            Tariff valuation — what is the price of the goods for which the tariff is applied?
3.            The country of origin allows the importer to determine from what country the goods come from for customs purposes.

In addition to exporting the finished WEAs from China, Mango may need to import materials and parts into China in order to make the WEAs. Mango will be required to comply with the pertinent import laws of the PRC. Under the Customs Law of the People’s Republic of China, both importers and exporters must register with Customs before filing declarations. Importers are required to file declarations with Customs at the port of entry within 14 days of the goods arrival. Exporters are to file declarations within 24 hours before the goods are loaded for shipment. China’s tariff rates are determined by the origin of the goods and via its tariff codes, the Harmonized Commodity Description and Coding System (“HS”), which is a “multipurpose international product nomenclature developed by the World Customs Organization.”

Mango will also be required to comply with a Value-added Tax (“VAT”) on some of its imported goods. Under the Provisional Regulation of the People’s Republic of China on Value-added Tax, “All units and individuals which and who, in the territory of the People’s Republic of China … import goods, shall be the taxpayers of value-added tax … and should pay the value-added tax in accordance with this Regulation.” The VAT applies to imports of goods within China of 24 specified items.  Metal mineral products used to make the Orange Boxes, which fall onto the specified list, will be taxed at 13% and other off-list materials used to make the Orange Boxes will be taxed at 17%. The VAT does not apply to exported goods.

 Import and Export Issues: National Security

Since Mango will be transferring technology to foreign nationals, it will need to comply with certain export controls promulgated by the US government for purposes of national security. Specifically, Mango will need to ensure the patents and know-how it is licensing to Silverwolf are not subject to the U.S. Department of Commerce’s Export Administration Regulations (“EAR”), the U.S. Department of State’s International Traffic in Arms Regulations (“ITAR”), or the US Department of State’s Arms Export Control Act (“AECA”).

If the technology is determined to be an export-controlled material under the EAR or ITAR, it will be unlawful for Mango or its agents to disclose the “Export-Controlled Materials” orally or visually to any foreign persons. Therefore, if the WEA technology is determined to be an “Export-Controlled Material,” Mango may need to abandon its plans to have the technology manufactured overseas. Still, as discussed below, counsel does not find it likely that the WEA technology will be determined an “Export-Controlled Material.” Moreover, even if the technology is subject to certain export controls, a license can be obtained to allow Mango to continue with its plans.

The Commerce Department’s EAR administers the export of US origin goods and technology. Mango’s technology is new and is intended for retail consumer purposes; it is not entirely clear whether the WEA technology should be subject to licensing before export. Still, it is possible it will be subject to such licensing because WEAs may serve a “dual-use” application — a technology capable of being used for both civilian and military purposes. Moreover, commercial items that may not have an obvious military application may be subject to the EAR.

WEA technology is not specifically numerated on the Commerce Control List (“CCL”), and will likely not be subject to a license. However, the spirit of EAR would leave counsel to believe Commerce may classify the WEA technology under EAR99, the portion of the CCL which applies to technologies not specifically numerated in the EAR (and items not controlled by another agency).

Mango will also need to reference the Commerce Country Chart to identify the “reasons for control” of certain items being exported to China. Because the WEA is not specifically listed in the CCL, it is not clear whether it falls under one of the reasons for control subject to export to China. In addition, Mango will not be subject to any “person-based” controls because Silverwolf, the potential end-user, is not included on any of the pertinent lists (Entity List, Treasury Department Specially Designated Nationals and Blocked Persons List, The Unverified List, or Denied Persons). Mango will need to apply for an export license unless it determines its technology is outside the scope of the CCL or another agency’s controls (see below). We believe Mango should apply for an export license with Commerce regardless of its determination because of the novelty and unique characteristics of the WEA technology, and the uncertainty as to whether Commerce would consider it a dual-use item.

In addition to Commerce’s CCL, Mango’s WEA technology may be subject to the US State Department’s Defense Export Controls of the AECA. WEA’s are not listed in the US Munitions List. However, there is a section for miscellaneous articles. Because of the novelty and uniqueness of the WEA technology, we advise Mango to file a Commodity Jurisdiction request to determine whether the technology is subject to export controls under the AECA and ITAR.

 Shipping

Mango has determined that it will be shipping the Orange Boxes via boat and truck. Silverwolf will load the packaged Orange Boxes onto trucks leased by the China Ground Shipping Company, a state-owned enterprise with a fabulous reputation for efficiency. From there, the goods will be loaded onto the Water Lily, a ship Mango contracted from American Sea Shippers, Inc. The Water Lilly will deliver the goods to a port in New York, NY, where they will be unloaded onto a truck operated by American Logistics, LLC. The truck will then deliver the goods to a warehouse owned by Mango in Newark, NJ. There are three important bodies of law that may govern this transaction — the United Nations Convention on Contracts for the International Sale of Goods (“CISG”), the Carriage of Goods by Sea Act (“COGSA”), and potentially the International Commercial Terms.

First, the United Nations Convention on Contracts for the International Sale of Goods (“CISG”) applies to the sale of goods between parties whose places of business are in different contracting states. Both the US and China are signatories to the CISG. The CISG will apply to this transaction unless the parties decide to “opt-out” of the CISG, which they may do under Article 6. According to Article 6, parties may expressly state in their contract that it is not to be governed by CISG. It is also important to note that the CISG is not all encompassing as certain types of transactions and portions of transactions are excluded from outside its scope. Therefore, domestic law or a choice of law analysis may come into play if a dispute arises.

Second, the Carriage of Goods by Sea Act (“COGSA”) will apply to the shipment of the goods while at sea. COGSA is a mandatory US law governing the bill of lading (“B/L”), a document that functions as a receipt, contract of carriage, and document of legal title during the shipment of goods. The B/L is an agreement that runs between the shipper and carrier. COGSA deals with those aspects of the B/L concerning the carrier’s obligations to transport and protect the goods during carriage. It limits the liabilities of damaged goods to $500 per package unless the parties agree otherwise. In addition, the parties may contract to extend COGSA to the inland portion of the shipment.

We advise Mango to include two important clauses in the bill of lading, subject to negotiations. First, the Clause Paramount is a provision that specifies which jurisdiction’s law will govern the agreement.  Second, an Intermodal Clause should also be included. COGSA only applies “tackle-to-tackle,” but an Intermodal Clause allows the parties to extend the limitations of liability under COGSA to the land portion of the shipment.

Finally, the parties may agree to implement International Commercial Terms (“Incoterms”) into the sales contract. Incoterms are a form of soft law and are promulgated by the International Chamber of Commerce (ICC) – Incoterms only apply when the parties agree to include them in the sales contract. Incoterms allocate certain tasks and the risk of loss during delivery to the buyer and seller of the goods (Mango and Silverwolf, respectively). The agreement between Mango and Silverwolf calls for the release of the goods by Silverwolf at its factory to Mango (through its leased shipping companies). Therefore the proper Incoterm to use in the instant case is the three letter EXW, short for Ex Works.

Arranging Payment

In negotiating a method of payment with Silverwolf, the manufacturer, it is advised that Mango should arrange for payment via a letter of credit, as bank transfers create substantial risks. Letters of credit tend to be more favorable to the buyer, and for this reason, Silverwolf may be unwilling accept payment via this method. Still, not all is lost as there are certain steps Mango can take to mitigate risk when making payment via bank transfer. This is especially true in this instant case because there is a prior relationship between Mango’s CFO and the manufacturer.

A letter of credit is a financing device that ensures payment to the seller of goods (in this case Silverwolf). A letter of credit allows a buyer to purchase goods even if it does not have the financing on hand because it is an undertaking between the buyer and an issuing bank — it is not a transaction that runs directly between the buyer and seller. The “applicant,” usually the buyer, has its “issuing bank” promise to honor drafts on itself against the presentation of specified documents, which usually includes the B/L and a commercial invoice. The “beneficiary” of the letter of credit, usually the seller, arranges with its local “confirming bank” to engage with the issuing bank to receive reimbursement from the issuing bank after it pays the seller. Letters of credit are usually governed by the Uniform Customs and Practice for Documentary Credit (“UCP”), a form of soft law incorporated into the contract by the contracting parties.

A letter of credit can protect Mango because it allows a buyer to cancel when a supplier does not ship on the agreed upon time, allows a buyer to cancel when a supplier does not match the specifications or there are too many defects, and allows a buyer to cancel when the documents do not fully conform to the letter of credit’s requirements. A bank’s ability to refuse payment for even the tiniest of discrepancies is called the “strict compliance principle.”

If Silverwolf requires that payment be arranged via bank transfer, there are certain steps Mango can take to limit risks. The standard form of bank transfer payment in China is called “30/70 TT,” which means a 30% down payment is to be made upon placement of the order, with the remaining 70% to be paid upon shipment. The risk involved here is that 100% of the payment is to be made before shipment, which means inspection may not occur until arrival; therefore, seeking reimbursement for a non-conforming good may be difficult. In addition, even if inspection is done before shipment, a 30% down payment will have already been made, and a refund of the 30% may become difficult.

However, Silverwolf and Mango’s CFO do have a history, so the likelihood of this occurring may be lower than most alternative manufacturers, but the risk still exists. To mitigate this risk, Mango should inspect the goods as early in the process as possible, should not make the second 70% payment until after the inspection, and once the relationship is further established seek to arrange a different method of payment.
Conclusion
            Mango’s plan to source its manufacturing of WEAs is quite feasible, but certain expenses should be taken into consideration including numerous legal expenses, taxes and tariff’s, and shipping costs. Through negotiations many risks can be mitigated, but there remain numerous challenges and uncertainties. Therefore, counsel advises Mango to continue with its current plan to source 25% of its manufacturing of WEAs, but to wait at least several years to build relationships and gain experience before it decides to source an even larger percentage of its WEAs for manufacturing.

Source: China law Blog

Link: http://www.chinalawblog.com/2013/04/sourcing-product-from-china-an-in-depth-look-part-ii.html