On Saturday, September 25th, Asia America Innovation Alliance (AAIA) held a panel discussion to take a closer look at the relationship between the Co-founders and legal service providers. In this event, guest speakers Shui, Li, Ted, and Sophia , along with the event moderator, Ling shared their experiences of engaging legal service providers.
Moderator: What are the functions you provide to either established and startup companies?
Feng: I will talk about legal services at a high level. Generally, legal services can be divided into two categories: legal counseling and legal proceedings (where you would need a lawyer to guide you through a legal process). Legal counseling involves various aspects, for example, lawyers can help ensure that the operation of a company is in compliance with government regulations. In the US, lack of knowledge about the law is usually not a defense. Consultations with lawyers are necessary especially when an industry is highly regulated. Consulting with a lawyer may also reduce business risks. For example, if a company is entering a new market, lawyers can provide counseling about the pros and cons, benefits, and risks in the new market.
As an IP lawyer, I can share some of my experiences here. If you are considering entering the US market with a new product, lawyers can provide some legal counseling. For instance, the lawyers can conduct a “freedom to operate” analysis to see if there are any patent barriers. If a company would like to apply for a patent or invalidate a patent at the Patent Office, a registered lawyer is generally needed to go through the legal process.
It’s worth noting that there are many areas in the law that are not black and white; legal counseling is usually needed to reduce risks for a company and the decision-makers.
Luo: I would like to further talk about this from the perspective of corporate and business law following the general introduction of legal services. In this respect, legal counseling is of the primary type. It mainly includes advising on various corporate matters, document drafting, negotiating, etc. For both startup and mature companies, a corporate lawyer can support from three aspects: first, compliance. Not only a business in strictly regulated industries should be careful about compliance with regulations, a company in a regular business will also be subject to a number of compliance issues. Taking the case I’m currently working as an example: a Chinese company has set up a Canadian subsidiary years ago engaging in software development business which is not subject to any industry-specific regulation. A due diligence exercise is initiated on the Canadian company as the Chinese company is undergoing IPO. During the due diligence, it was found that at the time of its incorporation, the company failed to file notification under the Investment Canada Act, which requires any foreign person that invests in Canada, whether to directly set up a new business or to acquire an existing business, to file a report to the Canadian government in charge of foreign investment. This is a typical non-compliance issue. Apart from this, while I was working for some small companies in relation to their organization documents, it was often found that there were some mistakes around their arrangements, such as board composition not being in compliance with the legal requirement of resident Canadian directors, which would also cause a significant negative impact on the company’s operation. Startup companies are particularly vulnerable to these kinds of non-compliance issues as they are constantly seeking external financing or may ultimately apply for IPO, but any non-rectifiable non-compliance issue may be fatal to such plans. It is important to do everything right at the beginning. Second, risks control. Risks can be everywhere. For example, when a company intends to issue shares to its founders, there could be issues relevant to an unstable shareholder structure, or a lack of a mechanism to deal with departing co-founders, which would cause problems in the future. When recruit employees, issues may arise from disputes under employment context, and when engaging third parties to undertake manufacturing process for products designed by it, proprietary technologies or information may be stolen or leaked. Lawyers can effectively lower the risks by reviewing or drafting relevant legal documents. Third, I would call it innovation. Particularly for startup companies in the innovation sector, they are facing a great deal of new things every day and are created to change the world as well. So do their lawyers. Lawyers representing those start-up companies will work together with them to jointly develop the new business model that suits the existing legal system. It is a creative process within both technical and legal frameworks, such as building a legal structure for a newly developed product or business model. For example, in the blockchain field, NFT has been used by some companies as a form of compensation for employees, which will require lawyers to adapt the existing employment legal documents to cope with such a new form of compensation. This innovative way might be popular in the future. This is brought about by technological innovation. As for the financing of start-up companies, people are now very familiar with SAFE (Simple Agreement for Future Equity), which was a new financing instrument created to replace the old and tedious legal documents for early-stage investment, and lawyers must have been involved in the process to design and create such instrument.
Moderator: What is your experience of engaging lawyers and any tips you learned?
Sophia: The enterprises I engage more with are already successful in China and have a certain market share in the US. They have finished the stage of capital accumulation and have the ability to directly set up factories or have the scale of investment up to tens of millions to hundreds of millions. However, with the deeper level of engagement with the US market, they have come across more legal issues, including disputes about business, employees, and community, etc. The cases that we come across often are out of the misunderstanding of Chinese entrepreneurs towards American law and regulations. Recently there has been a case called “Mengbaihe” which has caused an international sensation. Mengbaihe is a mattress producer in China which cooperated with an American company at first with the Chinese company being the supplier and the American company being the dealer. With the scale expanding, Mengbaihe has planned to get rid of the dealer and terminate the cooperation with the American company. It was supposed to be compensated only, but the court sentenced Mengbaihe to pay 20 million US dollars in compensation. We concluded that it was because they did not ask a lawyer to carefully analyze the contract where the company title printed in the contract and the one on the seal was not the same. As a result, the counter-party can sue multiple companies at the same time. This is a superficial omission that can be spotted very easily by lawyers. The lawsuit is still going on, but the case could have been settled under court. Now the lawyers were not optimistic about the follow-up situation and it is too late for them to examine the documents. My experience is that from the very beginning, even just for a simple contract, lawyers should be involved. Because small things may cause huge losses in the future. For both large and small enterprises, it is necessary to consult lawyers for any things with potential risks. The legal fees are far less than future losses.
Ted: Startup companies have limited resources, and their teams are rarely equipped with in-house lawyers. Thus, they need to use external legal resources. Young companies are often reactive and think legal services cost too much (even a simple agreement costs a lot). From my own experience, this is a kind of behavior that is lack of prior communication (did not reach the agreement on price with the lawyer in advance) and risk mitigation mindset. Issues can become severe if the lawyers have to intervene only when problems appear. They have to go through a lot of historical issues for the first time when facing the problems, which is a significant challenge. It is recommended either small start-ups or mature companies do not regard legal fees as a cost center but allow legal services to intervene early to create value. From my experience of serving as CTOs, IP lawyers should intervene in the early stage of R&D, handling the “freedom to operate”, avoiding infringement, and protecting the enterprise’s own IPs. There are a lot of specialties in this, requiring examination in advance. As the value of start-ups is to develop new things, managers should improve their awareness to protect IPs and avoid infringement.
Moderator: What are the expectations, limitations, or constraints that lawyers have with their clients? Legal expense?
Feng: Start-ups are very different from large companies. Communicating with large companies is usually easier to get on the same page because large companies are more experienced in legal affairs and have legal departments. Clients who are not familiar with the American legal system may think that lawyers can resolve all sorts of disputes. I’d like to emphasize that lawyers can’t solve all the legal problems because solutions have to be grounded on the laws and facts. For instance, there should be diligent investigations of the facts and law before a lawsuit is filed. If the facts and laws clearly do not support the lawsuit, it may be considered a bad-faith lawsuit, and the party in bad faith may be required to pay for the other party’s attorney’s fees.
Inexperienced lawyers sometimes may be prone to be “controlled” by a client. However, the client should not be a lawyer’s boss. It should be a collaborative relationship: the client seeks advice and the lawyer provides counseling.
Turning to legal expenses, sometimes a client may think that a problem is so simple but why the legal fee is so expensive. A seemingly simple legal question may involve complex issues. For example, a client may ask: when does a patent expire? The question seems very simple. However, there is a complex body of laws and regulations regarding a patent term in the United States. There are various rules about patent term extensions to account for certain delays at the FDA or the Patent Office. There are also situations where similar patents have been applied for, the so-called double patenting, where the patent owner can disclaim a portion of a patent term. The process can be far more complicated than the client would have thought, especially for patent portfolios owned by large companies, where patents are interconnected and the term of one patent may involve dozens of other patents.
In addition, the U.S. legal system is a case law system, where new cases come out every day from the court. Lawyers will need to check case law frequently. That would add up the cost of legal services.
Luo: Having dealt with various clients, I do come across some examples of mismatched expectations. Typical thought about the lawyer is: “you are a lawyer and you should know everything so just do whatever you suppose to do”. However, they do not realize that lawyers are not a living encyclopedia and do not know everything. Once I assisted a client with a construction contract, which typically includes technical specifications/standards as attachments. The client later asked me how come the technical specifications missed one item. However, the client or its engineers should be the one who is responsible for the technical aspect, not the lawyers. So, the client does need to read the contract itself. Lawyers do not know everything. A contract relates to legal, commercial, and technical aspects. Except for the technical issues, the client should also consider commercial arrangements, as well as they, know their business better. As can be seen in Sophia’s example, the client should consider the cooperation model and term of cooperation initially and communicate with their lawyer when the contract was first drafted as their lawyers have little idea about what the clients envisage in the near future. If they had such communication and built the necessary mechanism in the contract for future termination or change, the problem could have been avoided. Secondly, some clients think that lawyers just finish tasks by following the standard rules. However, there is no market norm for most of the transactions the subjects of the legal work. Terms are the results of negotiation which depends on the position of both parties. Lawyers are here to find a win-win turning point, which demands experience and skills. Contracts differ in various scenarios.
Thirdly, many clients expect immediate response by lawyers, hoping them to be on calls always. But lawyers serve various clients and work in a pipeline manner with their own schedule. There should be a reasonable expectation for feedback timing. Finally, as for costs, lawyers charge by time which varies from project to project. It is hard for lawyers to fix the price for every job in advance except for some routine tasks. With regard to cost control concern of clients, I would like to share some tips based on my personal experience which may not be universal to all lawyers. (1) Lawyers are more and more appreciating the clients’ desire for cost control and are willing to provide a fee estimate before being engaged. The final bill may differ from the estimation, but normally not significantly; (2) Try to avoid duplication of work if multiple lawyers are put in the team which is typical in big law firms. Though junior lawyers have lower rates, the adding-up of both junior and senior lawyers on a single job will increase the amount in the bill for sure. So it would probably be more efficient to just designate the person that have the required experience to fulfill the task. All those issues including what kind of lawyers to be involved can be communicated between lawyers and clients. (3) Well-prepared questions help reduce the communication time.
(4) Sufficient communications are significant. A healthy and long-term relationship between lawyers and clients can help lawyers solve problems more efficiently.
Sophia: Legal fee is indeed expensive, normally 400-500 per hour and can be up to 1500 per hour. Nevertheless, include the legal fee in the budget plan. Lawyers are necessary for key nodes such as contract.
Senior lawyers can answer questions quickly but juniors might need more time for research. The rate might end up even. Better find a lawyer that is suitable for the enterprise.
Moderator: How to improve communication efficiency between lawyers and their clients?
Feng: Communication efficiency is very important. Efficient communication can save time and cost, as legal fees are expensive. Providing information piecemeal might increase workload, time spent, and expenses.
The role of lawyers in communications is particularly important as they are usually taking the leading role. If a lawyer has an outline or a list of questions in hand, it may be easier to guide the conversation. Lawyers are usually experts in law and the clients are more familiar the technical and commercial field. It is important to not assume the other people to be experts in your area; otherwise people would be talking in parallel.
Face-to-face or oral communications are usually better for more complex and high-level issues, while certain details, such as technical details in patent documents, are better communicated through written form.
Sophia: From the perspective of manufacturers, lawyers’ documents are difficult to understand. When a company reaches a certain scale, setting up a legal department is necessary. This is the most efficient way to communicate with lawyers. Communication with people outside legal field is more easily to generate misunderstanding. Legal department is essential which should be included in the budget plan. A lot of cases tell us that don’t risk big things for the sake of small ones.
Ted: Raise internal awareness of legal matters, such as compliance, risk control, IP protection (protection for the enterprise’s patent, etc.). It is also necessary to enhance legal awareness among developers as it enables smooth communications. Lawyers face challenges if developers have no idea about legal issues. Furthermore, internal training on legal knowledge such as protection of intellectual property can reduce the potential risks in the legal process.
Luo: I’ll add on an example: A Chinese company invested 90 million US dollars in a US company, purchasing 51% of the shares. But the Chinese company still can’t control the US company, as they have no Board majority so the management of the company remained basically the same after the investment. The Chinese company actually hired a well-known US lawyer for this project but due to language and culture barriers, the negotiation was done mostly by the US lawyer on their behalf. The legal staff of the Chinese company mentioned to me (I actually represented the US company in this deal) privately that they did not understand why they could not control the Board with their 51% ownership. This problem could probably be attributable to communication misunderstanding. The Chinese company may have assumed that they would gain control after acquiring 51% ownership based on their experience in China, while the US lawyer may have dealt with this based on usual practice in US, i.e. the ownership and management rights are not equal. That being said, if the Chinese company have specifically discussed with the US lawyer on the board composition beforehand, they could possibly negotiate a better result. As such, there was probably a gap in their communication resulting in the misunderstanding, and a local lawyer who understands the mindset of both sides would be very beneficial for cross-border transactions. Thus, in order to solve problems more efficiently, it is important to treat lawyers as team members and maintain a long-term relationship, enable them to understand the company’s needs from the perspective of culture and thinking pattern. For example, for start-ups founded by the Chinese, I usually recommend having one shareholder holding a majority of the shares so that he/she can make the final decision. There are many examples where disputes arisen among the founders where they held equal shares in the company. However, this is different for start-ups founded by people who grown up in western culture.
Moderator: Any suggestions for startup companies or established companies?
Ted: Improve legal awareness. Don’t consider legal services as a cost center but a long-term partner.
Sophia: Include the legal fee in the budget.
Feng: Collaborate with a law firm that is responsive and easy to communicate with.
Luo: Treat lawyers as a part of the team.