A foreign manufacturer that outsources production to China is sharing its trade secrets — the manufacturing process, the material specifications, the quality control parameters, the supplier list, the customer list — with a Chinese factory that may become a competitor. The risk is not hypothetical. We’ve seen cases where the contract manufacturer used the foreign company’s process knowledge to develop its own competing product, where the factory’s former employee took the customer list to a new employer, and where the factory’s owner established a parallel business using the foreign company’s technology.
Trade secret protection in China is legal, contractual, and practical. The law provides rights, the contract defines obligations, and the practical measures are what actually protect the information day to day. Here’s how to protect trade secrets in a Chinese manufacturing relationship.
The Legal Basis
Chinese law protects trade secrets through the Anti-Unfair Competition Law. A trade secret is defined as technical information, business information, or other commercial information that is not known to the public, that has commercial value, and that the rights holder has taken reasonable measures to keep confidential. The definition is consistent with the definition in most developed countries.
The Anti-Unfair Competition Law prohibits the acquisition of trade secrets through theft, bribery, fraud, coercion, or other improper means. It also prohibits the disclosure, use, or permitting others to use trade secrets that were acquired through improper means. The law provides for civil remedies — damages, injunctions — and administrative penalties — fines, confiscation of illegal gains — and for criminal penalties in serious cases — imprisonment for the individuals responsible and fines for the company.
The civil remedy requires the rights holder to prove that the information is a trade secret, that the defendant acquired it through improper means or disclosed or used it in violation of a confidentiality obligation, and that the rights holder suffered damage as a result. The proof of damage is the most difficult element — how much revenue did the rights holder lose because the defendant used the trade secret, or how much profit did the defendant make from the use — and the damages may be modest relative to the value of the trade secret.
The administrative remedy is faster and less expensive than litigation. The rights holder files a complaint with the local Administration for Market Regulation — the AMR — which has the authority to investigate and to impose fines and to order the cessation of the infringement. The administrative remedy is effective when the infringement is clear and the infringer is a known entity at a known address. It’s less effective when the infringement is hidden or when the evidence is complex.
The Contractual Protection
The manufacturing agreement should include a confidentiality clause and a trade secret clause. The confidentiality clause defines the confidential information — the manufacturing process, the material specifications, the quality control parameters, the supplier list, the customer list, the pricing information — and restricts the manufacturer’s use of the information to the performance of the agreement. The clause should state that the information remains the property of the foreign company and that the manufacturer must return or destroy the information at the end of the agreement.
The trade secret clause goes further. It defines the trade secrets separately from the general confidential information — the trade secrets are the subset of confidential information that’s particularly valuable and particularly sensitive — and it imposes continuing obligations after the agreement ends. The non-disclosure obligation for trade secrets should be perpetual — the manufacturer can never disclose or use the trade secrets, even after the agreement has ended. The perpetual obligation is necessary because a trade secret doesn’t expire — a manufacturing process that remains secret remains a trade secret indefinitely.
The non-compete clause prohibits the manufacturer from using the trade secrets to compete with the foreign company. The non-compete is narrower than a general non-compete — it doesn’t prohibit the manufacturer from manufacturing generally, only from manufacturing products that use the foreign company’s trade secrets. The non-compete should be for a defined period — the period during which the trade secrets remain commercially valuable and not generally known.
The agreement should also address the manufacturer’s employees. The manufacturer should be required to impose confidentiality obligations on its employees who have access to the trade secrets, to maintain records of which employees have access to which trade secrets, and to notify the foreign company of the departure of any employee who had access to the trade secrets — and the destination of the employee, to the extent the manufacturer knows it.
The Practical Measures
The contractual provisions are valuable, but they’re enforced after a breach. The practical measures prevent the breach. The most important practical measure is access limitation — not all employees of the manufacturer need access to all of the foreign company’s trade secrets. A production worker who operates a machine on a production line doesn’t need to see the full manufacturing process specification or the material formulation — the worker only needs to see the specific instructions for the specific operation. The process specification can be divided into segments, and each segment is accessible only to the employees who need it for their work.
The access limitation can be physical — the sensitive documents are kept in a locked cabinet or a restricted area that’s accessible only to authorized personnel — or electronic — the sensitive files are password-protected or encrypted, and the access log records who accessed which file and when. The physical and electronic access controls create a record of access that supports an investigation if a trade secret is leaked.
The second practical measure is marking. Every document, every file, every drawing, every specification that contains trade secret information should be marked — “Confidential,” “Trade Secret,” “Proprietary Information” — in Chinese. The marking reminds the person handling the document that it’s confidential, and it supports the legal argument that the manufacturer knew or should have known that the information was confidential. A document that’s not marked is harder to protect because the manufacturer can argue that it didn’t know the information was confidential.
The third practical measure is the cleanup at the end of the relationship. When the manufacturing relationship ends — whether the agreement expires, the foreign company changes manufacturers, or the relationship is terminated — the foreign company should retrieve all physical and electronic copies of its trade secrets from the manufacturer. A manufacturer that retains copies of the trade secrets after the relationship has ended is in possession of the trade secrets without authorization, and the unauthorized possession is a breach of the confidentiality obligation.
The cleanup should be systematic — a list of all the trade secret documents that were provided to the manufacturer, a physical inspection of the manufacturer’s premises to confirm that the documents have been returned or destroyed, a written confirmation from the manufacturer that all copies have been returned or destroyed, and a reminder to the manufacturer of the continuing confidentiality and non-use obligations.
The Monitoring Program
A trade secret protection program includes monitoring — checking whether the trade secrets are being used by competitors or former employees. The monitoring can be product-based — purchasing competing products on the Chinese market and analyzing them for evidence that the manufacturer used the foreign company’s trade secrets — or market-based — monitoring industry publications, trade show exhibits, and patent filings for information that appears to be derived from the trade secrets.
The monitoring should be conducted periodically, and the frequency depends on the value of the trade secrets and the risk of misappropriation. A trade secret that’s the core competitive advantage of the foreign company — the secret formula, the proprietary process, the unique design — should be monitored more frequently than a trade secret that’s a minor improvement on a generally known process.
A trade secret that’s discovered to have been misappropriated should be pursued promptly. The longer the misappropriation continues, the more damage it does and the harder it is to stop. The first step is a cease-and-desist letter to the suspected infringer — the letter states that the recipient is using trade secrets that belong to the foreign company and demands that the recipient stop the use and return or destroy the information. The letter may be enough to stop the infringement if the infringer didn’t realize that the information was a trade secret — for example, a manufacturer that received the information from a former employee of the original manufacturer may not have known.
If the cease-and-desist letter doesn’t work, the next step is an administrative complaint to the AMR or to the public security bureau — the criminal enforcement route. The administrative and criminal routes are faster and less expensive than litigation, and they’re appropriate for a clear case of trade secret theft where the evidence is strong.
The Employee Dimension
Many trade secret cases in China involve employees — a former employee of the manufacturer who moves to a competitor and takes the trade secrets, or a former employee of the foreign company who moves to a Chinese manufacturer and takes the customer list or the technical specifications. The employee dimension requires the foreign company to address the trade secret risk through the manufacturer’s employees — the contractual obligation on the manufacturer to impose confidentiality obligations on its employees — and through its own employees — the employment contract with confidentiality and non-compete clauses.
The foreign company’s employment contracts should require employees in China to maintain the confidentiality of the company’s trade secrets and should prohibit post-employment competition for a defined period if the employee had access to trade secrets. The non-compete must be reasonable in scope, geography, and duration — a non-compete that prohibits the employee from working in the industry anywhere in the world for five years is unreasonable and unenforceable. A non-compete that prohibits the employee from working for a competitor in China for one or two years is more likely to be enforceable.
The non-compete must be compensated — the employer must pay the employee during the non-compete period. The statutory minimum compensation is 30% of the employee’s average monthly salary for the 12 months before termination, but the local rules may set a higher minimum, and an enforceable non-compete generally requires compensation at 50% of the average salary or higher.
